Examguide PDF

FOREWORD
The June 2002 revision of the Examiner’s Guide is a comprehensive

revision that incorporates the risk-focused program with the primary
goal of ensuring the overall safety and soundness of the credit union
system. The risk-focused program evaluates the degree to which credit
union management identifies, measures, monitors, and controls (i.e.,
manages) the existing and potential risks in their operations.
The risk-focused program is a forward-looking program designed to

increase the effectiveness and efficiency of the examination and
supervision process. Examiners will perform a risk assessment using
the new Scope Workbook and will draw on their professional
judgment to better target their efforts to the areas of greatest existing
and potential risk. The risk-focused program shifts the examination
and supervision emphasis from primarily a transactional review to
primarily a process review, meaning that it requires examiners to
review the credit union’s planning process, policies and procedures,
and internal controls. Examiners must also talk with management
about recent and proposed changes in products and services and assess
management’s due diligence regarding existing, new, and proposed
products and services to ensure the planning process considered and
addressed all related risks.
Required examination procedures have decreased to three: (1)

reviewing the supervisory committee audit, (2) reviewing the accuracy
of the 5300 Call Report, and (3) reviewing the credit union’s Bank
Secrecy Act program. The examiner’s risk assessment will determine
what additional examination and supervision procedures are
appropriate.
Many credit unions will look to their examiners to educate and inform
them about how to improve their risk management and to convey
specifics about NCUA’s risk-focused program. This Examiner’s Guide
provides information about the risk-focused approach in many areas of
the credit union’s operation, and discusses the risks inherent in
services and products that the credit unions may be considering.
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FOREWORD
This Guide also addresses the changes in funding requirements for the
Allowance for Loan and Lease Losses (ALLL) account, mandated by
generally accepted accounting principles (GAAP). This change is
independent of the risk-focused program, but took place at the same
time.
The Automated Integrated Regulatory Examination System (AIRES)

has also undergone extensive revision to allow it to better
accommodate a risk-focused program. AIRES and the new Scope
Workbook allow the examiner, who is onsite and best able to assess
the risks in the credit union, to determine the level of scope appropriate
for the areas of risk. The risk-focused program will enable examiners
to use their professional judgment to balance effectiveness and
efficiency.
Representatives from the National Association of State Credit Union

Supervisors (NASCUS) were represented on the National Examination
Committee and had a voice in the re-writing of the Guide.
Finally, a reminder that the Examiner's Guide remains a guide, not a

regulation. The guidance herein is dependable, but may not be the best
+&
or final approach in every situation. Examiner judgment and flexibility
remain crucial to a successful risk-focused program.
J. eo ard Skiles
aecutive Director
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Examiner's Guide
TABLE OF CONTENTS
Risk-Focused Program ............................................................................. Chapter 1

Scope Development and Planning ........................................................... Chapter 2
Risk Indicators ............................................................................. Attachment 2.1
Total Analysis Process ............................................................................. Chapter 3
Internal Controls ...................................................................................... Chapter 4
Conflicting Management Positions .............................................. Appendix 4A
Information System Reports ...................................................... ..Appendix 4B
Supervisory Committee............................................................................ Chapter 5
Opinion Audits ............................................................................. Appendix 5A
Examination of Internal Control Over Call Reporting By A CPA
...................................................................................................... Appendix 5B
Agreed Upon Procedures Engagements....................................... Appendix 5C
Non Opinion Audits ..................................................................... Appendix 5D
Information Systems and Technology...................................................... Chapter 6
Internet and e-Commerce............................................................. Appendix 6A
Management............................................................................................. Chapter 7
General Ledger ......................................................................................... Chapter 8
Cash Analysis........................................................................................... Chapter 9
Wire Transfers ............................................................................. Appendix 9A
Automated Clearing House Network ........................................... Appendix 9B
Item Processing ............................................................................ Appendix 9C
Loans - General Loan Review Part 1 ....................................................... Chapter 10/1
Loans - Credit Risk, Delinquency, & Charge Offs Part 2 ........................ Chapter 10/2
Loan Types .................................................................................. .Appendix 1OA
Glossary of Loan Terms ............................................................... Appendix 10B
Member Business Loan Financial Ratios..................................... Appendix 1OC
Sample IDFP Agreements............................................................ Appendix 10D
Real Estate Loan Documentation Checklist................................. Appendix 1OE
Allowance for Loan and Lease Losses..................................................... Chapter 11
ALLL Facts, Questions, and Answers ......................................... Appendix 11A
Investment Analysis ................................................................................. Chapter 12
Glossary of Investment Terms ..................................................... Appendix 12A
Asset Liability Management (ALM) Part 1 ............................................. Chapter 1311
ALM-Interest Rate Risk Part 2 ................................................................ Chapter 13/2
ALM-Liquidity Risk Part 3 ...................................................................... Chapter 13/3
Interest Rate Risk Measurement Tools ........................................ Appendix 13A
Discounting Cash Flows .............................................................. Appendix 13B
Glossary of ALM Terms .............................................................. Appendix 13C
Share Structure......................................................................................... Chapter 14
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Types of Share Accounts ............................................................. Appendix 14A

Share Account Red Flags ............................................................. Appendix 14B
Profitability .............................................................................................. Chapter 15
Net Worth and Other Equity Accounts .................................................... Chapter 16
Prompt Corrective Action Part 1.............................................................. Chapter 17/1
PCA .Risk-Based Net Worth Requirement Part 2 ................................. .Chapter 17/2
Weighted Average Life ................................................................ Appendix 17A
NWRP Sample Format ................................................................ Appendix 17B
Regulatory Compliance............................................................................ Chapter 18
Bank Secrecy Act (BSA) ............................................................. Appendix 18A
RegFlex ........................................................................................ Appendix 18B
Money Laundering Red Flags ...................................................... A t t a c ~ e n 18.1 t
Consumer Compliance............................................................................. Chapter 19
Credit Practices Rule .................................................................... Appendix 19A
Equal Credit Opportunity Act (ECOA) ....................................... Appendix 19B
Home Mortgage Disclosure Act (HMDA) ................................... Appendix 19C
Expedited Funds Availability Act ................................................ Appendix 19D
Children's Online Privacy Protection Act (COPPA).................... Appendix 19E
Electronic Funds Transfer Act ..................................................... Appendix 19F
E-Sign Act .................................................................................... Appendix 19G
Fair Credit Reporting Act (FCRA) ............................................ ..Appendix 19H
Fair Debt Collection Practices Act (FDCPA) .............................. Appendix 191
Fair Housing Act (FHA) .............................................................. Appendix 19J
Flood Disaster Protection Act (FDPA) ........................................ Appendix 19K
Home Owners Protection Act (HOPA)....................................... Appendix 19L
Consumer Leasing........................................................................ Appendix 19M
Privacy ......................................................................................... Appendix 19N
Real Estate Settlement Procedures Act ........................................ Appendix 190
Right to Financial Privacy Act (RFPA) ....................................... Appendix 19P
Soldiers' and Sailors' Civil Relief Act .......................................... Appendix 19Q
Home Ownership and Equity Protection Act (HOEPA) .............. Appendix 19R
Truth in Lending Act .................................................................... Appendix 19s
Truth in Savings Act .................................................................... Appendix 19T
Report Writing .........................................................................................Chap ter 20
AIRES Reports............................................................................. Appendix 20A
Joint Conferencemxit Meeting ................................................................ Chapter 2 1
Examination Evaluation and Review Policy............................................ Chapter 22
DOS Review and SE Evaluation Forms ...................................... Appendix 22A
State Credit Union Report Reviews ............................................. Appendix 22B
State Examination Report Review Summary............................... Attachment 22.1
Low-Income Credit Unions...................................................................... Chapter 23
Shared Branch .......................................................................................... Chapter 24
Shared Branch CUSO .................................................................. Appendix 24A
Shared Branch CUSO Review Procedures .................................. Appendix 24B
Credit Union Service Organizations ........................................................Cha pter 25
Sample CUSO Review ................................................................. Appendix 25A
Financial Liquidity Ratios ............................................................A ppendix 25B
Federally Insured State-Chartered Credit Unions (FISCUs) .................... Chapter 26
Application and Agreement for Insurance ................................... Appendix 26A
Shortages.................................................................................................. Chapter 27
Warning Signals ........................................................................... Appendix 27A
Bond Coverage......................................................................................... Chapter 28
Special Assistance, Letters of Understanding And Agreement, Conservatorships, and
Special Actions ........................................................................................ Chapter 29
Administrative Actions ............................................................................ Chapter 30
Liquidations ............................................................................................. Chapter 3 1
Chapter 1
RISK FOCUSED PROGRAM

TABLE OF CONTENTS
RISK-FOCUSED PROGRAM ........................................................................................ 1-1

Supervision Objectives ........................................................................................ 1.1
Overview .............................................................................................................. 1. 1
Due Diligence ...................................................................................................... 1-2
Risk-Focused Supervision ................................................................................... 1-3
Risk-Focused Examination .................................................................................. 1-4
Risk Categories .................................................................................................... 1-5
Credit Risk ............................................................................................... 1-6
Interest Rate Risk ..................................................................................... 1-6
Liquidity Risk .......................................................................................... 1-6
Transactional Risk ................................................................................... 1-6
Compliance Risk ...................................................................................... 1-7
Strategic Risk ........................................................................................... 1-7
Reputation Risk ........................................................................................ 1-7
Managing Risk ..................................................................................................... 1-8
Risk Management Program...................................................................... 1-8
Policies, Processes, Personnel, and Control Systems .............................. 1-10
Measuring and Assessing Risk ............................................................................ 1-11
Supervisory Risk Areas ........................................................................................ 1.12
Benefits of Risk-Focused Supervision ................................................................. 1-13
Risk-Based Examination Scheduling................................................................... 1-14
Risk-Focused Supervision ................................................................................... 1-15
Supervision Tools ................................................................................................ 1-16
5300 Call Report Review ......................................................................... 1-16
Examination Planning Activities ............................................................. 1-18
5300 Risk Parameters .............................................................................. 1-21
Cycle-to-Cycle Comparisons ................................................................... 1-22
Consolidated Balance Sheet ..................................................................... 1-22
Documenting Supervision Plans .......................................................................... 1-23
Documenting Changes in Risk Profile and Supervision Plans ................1-24
Supervision and District Management ................................................................. 1-24
Supervision of CAMEL 3, 4, and 5 Credit Unions .............................................. 1-25
Administrative Record ............................................................................ . l -27
Chapter I
RISK-FOCUSED PROGRAM
Supervision Evaluate management’s due diligence processes over the credit
Objectives union’s activities
0 Stay abreast of local and national economic conditions that may
affect the financial performance and health of credit unions
0 Evaluate the credit union’s current and potential risk
0 Evaluate management’s ability to identify, measure, monitor, and
control (i.e., manage) risk
0 Evaluate the adequacy and accuracy of management’s risk
reporting and monitoring mechanisms
0 Assess the credit union’s ability to withstand any negative effects
of risks taken in relation to its financial condition and net worth
position
Identify changes in the credit union’s risk profile and adjust
supervision plans accordingly
Identify and address emerging risk issues before they become
serious problems
Work with management to resolve problems identified during
onsite and offsite contacts
Work with management to reach agreeable solutions to reduce
levels of unwarranted risk
Direct resources more efficiently by compiling and assimilating
relevant risk information that helps prioritize examination
schedules and determine need for subject matter examiners (SMEs)
and specialists
Develop a factual, documented administrative record of the credit
union’s problems and the attempts to resolve them
Overview A risk-focused program is a forward-thinking approach that allocates

resources to the credit unions and areas exhibiting weaknesses or
adverse trends. Examiners allot time to reviewing areas containing the
most risk for an individual credit union. Activities posing the highest
risk receive the most scrutiny.
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EXAMINER'S GUIDE
In the risk-focused program, distinctions between examination and

supervision blur. Examination and supervision efforts may, at times,
be a continuum to the extent that examiners will call a particular
contact an examination, rather than supervision simply because the
time frame requires an examination.
Supervision is the ongoing monitoring of a credit union's financial and

operational condition. During supervision in the risk-focused program,
the examiner looks forward at the direction a credit union takes and the
decisions it makes. Examiners can then anticipate when those
decisions could result in the credit union assuming undue risk or
failing to manage the risk it has taken. Examiners may determine or
adjust the timing of the examination based on conditions revealed
during the supervision process.
The examiner, through other examiners, trade associations, credit

union leaders, news reports, etc., should stay abreast of developments
within their district credit unions and the various industries or
communities that affect the credit unions. Examiners should act on
potentially high-risk activities and problems by contacting credit union
officials to verify information received. Depending upon their comfort
level after speaking with credit union personnel, they may decide to
perform an onsite contact to gain first hand knowledge of the situation,
or may reschedule the examination to an earlier date. Examiners
should keep their supervisory examiners informed of potentially
serious conditions that could adversely affect the credit union.
Due Diligence Credit unions should have in place a risk management program that
includes a strategic plan with implementing policies, procedures, and
internal controls necessary to manage the risks inherent in their
operations. Successful risk management programs rely on credit union
management to employ sufficient staff and have available necessary
resources to identifl, measure, monitor, and control existing and
potential risks.
Management's due diligence involves the analysis of new products and

services as well as the ongoing analysis of the credit union's current
products, services, and operations to ensure their relevance, efficiency,
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and effectiveness. This analysis would include periodic cost-benefit

studies.
If the risk to the credit union increases as a result of offering a certain

product or service, the credit union should determine whether the
additional risk is worth the benefit to the credit union. If not, the credit
union may decide to discontinue the product or service. If management
decides to continue offering the product or service, they should explore
ways to mitigate the risk.
Risk-Foc used Risk, by definition, implies uncertainty. While performing risk-focused

Supervision supervision, examiners should look for sources of uncertainty within
the operation of the credit union. Based on their findings and using
their professional judgment, examiners will prioritize these risks by the
magnitude of the potentially adverse effect on the earnings and capital
of the credit union.
Financial indicators, while useful, often represent lagging indicators.

Indicators such as adverse trends, unusual growth patterns, or
concentration activities can serve as triggers of changing risk and
possible causes for future problems. However, the risk-focused
supervision approach emphasizes the anticipation of future problems
by analyzing processes that may serve as leading indicators. These
leading indicators include the following:
0 Due diligence review by management for new and existing

products and services;
Development and application of strong internal controls;
0 Analysis of financial outcomes; and
0 Measurement of actual performance against forecasted results.
Risk is fundamental to the operation of a credit union. Examiners,

therefore, should not insist that the credit union eliminate risk, but,
instead, should ensure that credit unions identify and manage their
risks. The desired reward for taking risk is stable profitability and
increased net worth. Credit unions must balance risk and reward
responsibly. The examiner’s job requires assessing that the appropriate
balance exists. That assessment begins with determining whether
management has performed adequate due diligence with respect to the
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EXAMINER’S GUIDE
risks present and anticipated in the operation of the credit union and
whether management has instituted sound internal controls to identify,
manage, and mitigate undue risk.
A credit union’s capital or net worth constitutes the reserve of funds

available to manage or absorb the risks to the institution. The amount
of capital that a credit union has accumulated is an important
determinant of the amount of risk it can assume.
Generally, credit unions that have more complex operations carry more
risk than do credit unions offering fewer products and services. Greater
risk requires the credit union to employ able, experienced management
and more sophisticated systems of control. The risk-focused
supervision system largely depends upon sound controls. These
controls include the following:
Informed officials;
Well-trained management and staff;
0 Sound policies and procedures;
Adequate due diligence by management prior to engaging in an
activity, and ongoing for existing products and services;
Sound system of internal controls;
0 Prudent risk limits; and
0 Identifying, measuring, controlling, monitoring and reporting of
risk exposures.
Risk-Focused In the risk-focused examination, the content of the examination centers

Examination on key areas of risk. Examiners should review due diligence by
management for new products and service, the credit union’s risk-
management systems, and the internal controls in place. Examiners
may, at times, find it necessary to use transaction testing to validate
their assessment of risk. They will focus on validating management’s
ability to identify, measure, monitor, and control risk. Some areas may
receive little or no review. The examiner has discretion in determining
areas requiring the most attention and allocating the time and resources
accordingly. Examiners’ emphasis focuses on managing future risks
successfully and not expending valuable resources on minor items
posing little risk to the safety and soundness of credit unions.
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The risk-focused program provides examiners the flexibility to focus

on areas exhibiting material current or potential risk. However, the
three minimum requirements of each risk-focused examination include
the following:
Reviewing the accuracy of the 5300 Call Report data;

0 Reviewing the supervisory committee audit; and
0 Reviewing the credit union’s compliance with the Bank Secrecy
Act (BSA).
Examiners must complete these minimum procedures during each

examination. However, examiners should understand that, depending
on the credit union, its risk characteristics, and the examiner’s
familiarity with that credit union, they will perform more than the
minimum procedures in most credit unions. Most credit unions will
require other procedures for necessary identification and evaluation of
existing and potential risks.
Although the actual evaluation of the minimum review areas may take
place during supervision contacts, the examiner should document the
review of these areas and any material concerns in the examination
report. Examiners must also assign the CAMEL rating during the
examination.
In carrying out the risk-focused examination program, examiners

should allocate examination time based on areas that manifest material
risk characteristics. This ensures supervisory attention remains
properly focused on credit unions exhibiting existing or potential
weaknesses or adverse trends.
Risk Risk is the potential that events, expected or unanticipated, may have
Categories an adverse effect on the credit union’s net worth and earnings. The
seven categories of risk for credit union supervision purposes are
Credit, Interest Rate, Liquidity, Transaction, Compliance, Strategic,
and Reputation. Any product or service may expose the credit union to
multiple risks; these categories are not mutually exclusive.
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EXAMINER’S GUIDE
Credit Risk Credit Risk is the current and prospective risk to earnings or capital
arising from an obligor’sfailure to meet terms of any contract with the
credit union or otherwise fail to perform as agreed. Credit risk exists in
all activities where the credit union invests or loans funds with the
expectation of repayment.
Interest Rate Interest Rate Risk is the risk that changes in market rates will
Risk adversely affect a credit union’s capital and earnings. Interest rate risk
arises from (1) differences between the timing of rate changes and the
timing of cash flows (repricing risk); (2) changing rate relationships
among different yield curves affecting credit union activities (basis
risk); (3) changing rate relationships across the spectrum of maturities
(yield curve risk); and (4) interest-related options embedded in credit
union products (options risk). Not only can a move in interest rates
affect the price of investments, it also has an effect on the value of the
loan portfolio and on fee income, which is sensitive to changes in
interest rates.
The assessment of interest rate risk should consider risk from both an
accounting perspective (i.e., the effect on the credit union’s accrual
earnings, including held-to-maturity and available-for-sale accounts)
and the economic perspective (i.e., the effect on the market value of
the credit union’s loans and investments.) In some credit unions, the
broader category of market risk captures interest rate risk.
Liquidity Risk Liquidity Risk is the current and prospective risk to earnings or capital
arising from a credit union’s inability to meet its obligations when they
come due, without incurring material costs or unacceptable losses.
Liquidity risk includes the inability to manage funding sources,
including unplanned decreases or changes. Liquidity risk also arises
from the credit union’s failure to recognize or address changes in
market conditions that affect the ability to liquidate assets quickly and
with minimal loss in value.
Transaction Risk Transaction Risk is the risk to earnings or capital arising from fraud or
error that results in an inability to deliver products or services,
maintain a competitive position, and manage information. This risk
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(also referred to as operating or fraud risk) is a function of internal

controls, information systems, employee integrity, and operating
processes. This risk arises on a daily basis in all credit unions as they
process transactions.
Compliance Risk Compliance Risk is the current and prospective risk to earnings or
capital arising from violations of, or nonconformance with, laws, rules,
regulations, prescribed practices, internal policies and procedures, or
ethical standards. Compliance risk may also arise in situations where
ambiguous or untested laws or rules govern certain credit union
products or activities of the members. Compliance risk exposes the
credit union to fines, civil money penalties, payment of damages, and
the voiding of contracts. Compliance risk can lead to a diminished
reputation, limited opportunities, reduced field of membership
expansion potential, and lack of contract enforceability.
Compliance risk goes beyond a failure to comply with consumer

protection laws. It encompasses all laws as well as prudent ethical
standards, contractual obligations, and exposure to litigation.
Compliance risk can blend into operational risk, transaction
processing, and even legal risk, increasing the difficulty of identifying
this risk.
Strategic Risk Strategic Risk is the current and prospective risk to earnings or capital
arising from adverse business decisions, improper implementation of
decisions, or lack of responsiveness to industry changes. This risk is a
function of the compatibility of a credit union’s strategic goals, the
business strategies developed to achieve those goals, the resources
deployed to accomplish these goals, and the quality of implementation.
The tangible and intangible resources needed to carry out business
strategies include communication channels, operating systems,
delivery networks, monitoring systems, and managerial capacities and
capabilities.
Repubtion Risk Reputation Risk is the current and prospective risk to earnings or
capital arising from negative public opinion or perception. Reputation
risk affects the credit union’s ability to establish new relationships or
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EXAMINER’S GUIDE
services, or to continue servicing existing relationships. This risk,

which occurs in activities such as asset management decisions and
transactions, can expose the credit union to litigation, financial loss, or
a decline in membership base. Reputation risk exposure appears
throughout the credit union organization. The officials, management,
and staff must accept responsibility to exercise an abundance of
caution in dealing with members and the community.
Managing The key to effective risk management is management. Effective risk

Risk management requires an informed board of directors, which guides the
credit union’s strategic direction including its risk tolerance. Board-
approved, written policies define the board’s strategic direction.
Procedures intended to carry out the board’s policies and well-
designed monitoring systems enable the board to hold management
accountable for operating within established tolerance levels.
Effective risk management also requires capable management and

staff. Management must maintain the integrity of the risk management
program, including evaluation of the credit union’s operational and
financial condition, and keep the directors informed of material
existing and potential risk. Management’s responsibilities include the
following:
0 Implementing the board’s strategic direction;
0 Developing formal and informal policies compatible with the

strategic goals defining the credit union’s risk tolerance;
0 Overseeing development and maintenance of timely, accurate, and

informative management information systems; and
0 Ensuring effective communication of, and adherence to, strategic

direction and risk tolerances throughout the organization.
Risk Each credit union should develop its own risk management program
Management tailored to its needs and circumstances. Differences in market
Program conditions, fields of membership, and credit union structures preclude
any single risk management program working for all credit unions. The
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size, complexity, and geographic diversity of each credit union

determine the sophistication required of its risk management program.
All sound risk management programs, however, have several common
fundamentals. For example, staff responsible for implementing sound
risk management programs must perform those duties independent of
the credit union’s risk-taking activities. Regardless of the risk
management program’s design, each should include:
0 Risk identification. Proper risk identification focuses on

recognizing and understanding existing risks or risks that may arise
from new business initiatives. Risk identification should be a
continuous process, and should occur at both the micro
(transaction) and macro (overall portfolio) levels.
0 Risk measurement. Accurate and timely measurement of risks is a

critical component of effective risk management. A credit union
with no risk measurement capabilities has limited ability to
monitor or control risk levels. Further, the sophistication of the risk
measurement tools should reflect the complexity of the operation
and levels of risk assumed. The credit union should periodically
verify the integrity of the measurement tools it uses. Good risk
measurement systems assess both individual transactions and
overall portfolios.
0 Risk control. The credit union should establish and communicate

control limits through policies, standards, and procedures that
define responsibility and authority. The credit union should adjust
these management tools if conditions or risk tolerances change.
Further, the credit union should implement a process to authorize
exceptions or changes to risk limits, if warranted.
0 Risk monitoring. Credit unions should monitor risk levels

regularly to ensure well-timed reviews of risk positions and
exceptions. Prompt distribution of frequent, accurate, and
informative monitoring reports to appropriate management and
staff enables them to take needed actions.
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EXAMINER’S GUIDE
Policies, When examiners assess risk management programs, they should

Processes, consider the credit union’s policies, processes, personnel, and control
Personnel, and systems. A significant deficiency in one or more of these components
Control Systems
constitutes a deficiency in risk management. The sophistication of
each system will vary depending upon the complexity of the credit
union’s operation. Credit unions with simple structures may require
and often have less formalized policies, processes, and control systems
in place than do credit unions with more sophisticated structures.
Policies reflect the board’s intent and commitment in pursuing desired

results. Effective management requires written policies that the credit
union adheres to in practice. Policies set standards and courses of
action to pursue, implement, and enforce specific objectives. Good
policies link with, and reflect, a credit union’s underlying mission,
values, and principles. They also clarify the credit union’s tolerance for
risk. Credit unions should have mechanisms in place to trigger a
review of policies in the event activities or tolerances change.
Processes include the procedures, programs, and practices governing

how a credit union will pursue its objectives and define how it will
carry out its daily activities. Good processes demonstrate consistency
with the underlying policies, efficiency, and adequacy of internal
control checks and balances.
Personnel encompass the staff and managers executing or overseeing

performance of the processes. Qualified, competent managers and staff
should perform as a conscientious board expects. They must
understand the mission, values, policies, and processes.
Control systems are tools and information systems managers use to

measure performance, assist in decision-making, and assess the
effectiveness of existing processes. Sound control systems require
timely, accurate, and informative feedback devices. In turn,
management must implement reporting systems by which they
communicate necessary and sufficient information to the directors.
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Measuring Ensuring effective risk-focused supervision requires a common

and framework to document decisions about risk. The risk assessment
Assessing portions of the Scope Workbook (discussed further in the Scope
Risk Development and Planning chapter) provide a method of
communicating and documenting judgments regarding the quantity of
risk, the quality of risk management, the level of supervisory concern,
and the direction of risk. Evaluating the seven categories of risks will
provide consistency to the risk assessment process. The evaluation
factors for consideration in making the assessments provide an
overview of issues that can assist in assessing risk.
Assessment of risk must reflect both a current and prospective view of

the credit union’s risk profile. Examiners should use this assessment to
drive supervisory strategies and activities, facilitate discussions with
management and directors, and conduct more efficient examinations.
Risk assessment will occur in all credit unions; however, small credit
unions may often require more transaction examining because limited
staff can impede internal control systems. Assessing risk enables the
examiner to provide a common supervisory philosophy while
recognizing the differing levels and complexities of risk present in
each credit union.
Effectively communicating the rationale for decisions in evaluating

risk assists the examiner in accomplishing the desired results from
supervision. Examiners should discuss conclusions from the risk
assessment with appropriate credit union officials and management.
Management’s input may help clarify or modify conclusions. These
discussions should help management understand the quantity of each
risk category (low, moderate, or high), determine the direction of each
risk category (decreasing, unchanged, or increasing), focus on the
strengths and weaknesses of risk management, and implement
corrective actions necessary to achieve future supervisory plans.
Examiners should assess the amount and direction of risk exposure for
the seven types of risk using a supervisory process that assesses the
fo1lowing:
0 Quantity of risk - the level or volume of risk (low, moderate, or

high);
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EXAMINER’S GUIDE
Quality of risk management - how well management identifies,

measures, controls, and monitors risk;
Aggregate risk - a summary of the level of supervisory concern

considering both the quantity of risk and the quality of risk
management, weighing the relative importance of each. Mitigating
factors not necessarily considered in the quantity of risk and quality
of risk management decisions (e.g., insurance) may influence the
examiner’s assessment of aggregate risk (i.e., low, moderate, high);
Direction of risk - assessed as decreasing, unchanged, or

increasing indicates the likely changes to the risk profile over the
next examination cycle. Decreasing direction indicates the
examiner anticipates, based on current information, the aggregate
risk will decline over the next examination cycle. Unchanged
direction indicates the examiner anticipates aggregate risk will
neither increase nor decrease. Increasing direction indicates the
examiner anticipates higher risk during the next examination cycle.
For example, when the credit union has moderate but decreasing,
credit risk, examiners can anticipate low or lower credit risk in the
next examination cycle. The direction of risk often influences both
the examiners’ examination and supervision strategy.
One of the most significant influences on the anticipated direction

of risk is whether the examiner expects management to take the
actions necessary to reduce unacceptable risks.
Examiners’ expectations of risk to increase or decrease do not

necessarily mean the risk level at the credit union will change
within the examination cycle. Examiners might expect movement
within the risk level (e.g., decreasing risk, but not enough to
change the characterization of that risk as high). Examiners should
provide comments explaining why they do not expect a change in
risk level.
SupetViSOty Generally, the seven areas of risk fall within two major categories:
Risk Areas
0 Market risks, which are usually more objective, and lend
themselves to measurement include:
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- Credit risk
- Interest rate risk
- Liquidity risk
Institution risks are more subjective and include:

- Transaction risk
- Compliance risk
- Strategic risk
- Reputation risk
Although the risk-focused examination and supervision process

identifies the seven risks as discreet and individual, in reality, these
risks are interrelated and inseparable. They often overlap, and risk in
one area can cause or mitigate risk in one or more additional areas.
Institution risk can result from market risk, and vice versa.
For example, compliance laws exist for protection of the consumers.

Most credit unions that have significant compliance risk do not
willfully set out to hurt their members; however, if the credit union
does not adhere to compliance laws, its reputation could suffer causing
increased reputation risk and possibly loss of members. Further, civil
money penalties could diminish or even eliminate a credit union’s
reserves, which could result in increased liquidity risk.
Benefits of On-going risk-focused supervision provides benefits to the examiner as

Risk-Focused well as to the credit union. Risk-focused supervision enables
Supervision examiners to do the following:
Focus on areas of major risk;

Focus on how well risk is managed over time, rather than at a
single point in time;
Identify risks more accurately;
Identify risks proactively;
Express risks in CAMEL ratings more meaningfully;
Minimize loss to the insurance fund in each credit union;
Streamline workpaper documentation to support areas of risk; and
Improve the quality of workpaper documentation and support for
conclusions.
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EXAMINER’S GUIDE
The most obvious benefit to many credit unions for sufficiently

identifying, managing, and mitigating their risks will be their eligibility
for a “may be delayed” category for risk-based examination
scheduling. Some additional benefits of the risk-focused supervision
system to the credit unions include the following:
0 Enables credit unions to focus on their major areas of risk;
0 Encourages credit unions to identify the risks inherent in their

current products and services and to seek ways to mitigate or
manage those risks;
0 Encourages credit unions to identify risks inherent in new or

proposed products and services and to address management of
those risks in the planning stage;
0 Encourages examiners to perform preliminary analyses offsite,

reducing disruption in credit union operations;
0 Encourages frequent, open communication between the credit

union and the examiner;
0 Provides officials in CAMEL Code 1 or 2 credit unions the option

to hold a joint conference with the examiner;
0 Encourages credit unions to review their processes and internal

controls and to correct deficiencies in those systems;
Encourages management to proactively identify risks through a

system of well-planned and carefully implemented due diligence;
and
0 Enables examiners to provide the officials with customized

examination reports that provide only workpapers and narrative
necessary to support the examiner’s analysis and conclusions.
Risk-Based Risk-based examination scheduling permits deferred scheduling of

Examination certain credit union examinations. When risk-based scheduling applies,
Scheduling those credit unions can receive two examinations in a three-year
Page 1-14
period. Examiners, after consulting with their supervisory examiners,

may use risk-based scheduling for credit unions assigned a CAMEL 1
or 2 for the prior two examinations, and having characteristics such as
the following:
In operation for at least 10 years;

Net worth ratio greater than 7 percent;
Positive return on assets;
No major or potentially adverse balance sheet changes;
Adequate ALM program;
Adequate internal controls;
Accurate books and records; and
No recent high-risk programs not yet reviewed.
Examiners perform offsite monitoring to review trends of credit unions

with deferred examination schedules. If needed, examiners may
schedule onsite supervision contacts when offsite monitoring indicates
potential risk that requires further assessment.
NCUA Instruction 5000.15 provides additional guidance on risk-based

examination scheduling.
Risk-Focused Risk-focused supervision procedures often include both offsite and

Supew ision onsite work, including the following:
Procedures
Examination planning;
Evaluating risk indicators;
Reviewing offsite monitoring tools and risk evaluation reports;
Developing the scope;
Conducting a risk assessment;
Developing and documenting conclusions and recommendations;
and
Communicating with credit union management.
Often (although not always), examination planning, evaluating risk

indicators, and scope development begin with offsite work. Offsite
monitoring procedures shape the examiner’s focus. The examiner
should involve credit union management in the discussion of
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EXAMINER’S GUIDE
subjective issues and mitigating factors; therefore, examiners will

usually assess risk and draw conclusions onsite.
SUpeWiSiOn Examiners have a variety of tools to aid in their supervision efforts,

Tools including the following:
Review of call reports (NCUA 5300s);

Examination planning contacts;
Periodic telephone contacts;
Review of credit union risk management reports (e.g., ALM
summary reports, investment shock tests);
Review of board and committee minutes;
Review of financial trends;
Cycle-to-cycle comparisons;
Review of consolidated balance sheets;
Review of ALM program and changes to ALM program, policies
and procedures;
Review of offsite risk evaluation and monitoring reports;
Review of publications, press releases, and news stories about
conditions and events that may affect the credit union;
Review of electronic information sources (e.g., credit union
website, NCUA website, etc.);
Review of the supervisory committee audit report and, if necessary,
the audit workpapers; and
Analysis of the Financial Performance Reports (FPRs).
5300 Call Report During each examination, examiners must verify the accuracy of the
Review 5300 Call Report. The risk-focused program places heavy reliance on
the accuracy of the data in the call report. Inaccuracies in the call
report may result in misleading evaluation data. Examiners should
stress to the credit unions the importance of reporting accurate
information on the call report.
Examiners should complete the 5300 Review questionnaire during the

preliminary phase of the examination. The questionnaire’s design
requires answers to four basic control questions. If the answers are
“Yes” then the remaining questions do not require an answer, thereby
Page 1-16
reducing the time spent reviewing a well-controlled 5300 reporting

process.
Examiners should focus their review on the internal controls over the
call report and the credit union’s process for ensuring its accuracy, by
taking the following steps:
0 Determine the experience level of the personnel involved in

preparing the call report. Examiners can usually place greater
reliance on a call report prepared by the same person for the last
several years. However, if the same person has prepared the call
report and year after year each examination notes deficiencies,
examiners should review the accuracy of the call report in detail.
0 Determine if the credit union has a verification process. Once

prepared, a second employee should verify the accuracy and
document the verification by signing off on the call report. If the
same person prepares the data, completes the call report, and
submits it to the examiner, the examiner should take additional
steps to verify the report’s accuracy.
Review the preparer’s process for confirming where the numbers

originated and documentation of that process. If this
documentation does not exist or is not readily available (i.e.,
stapled to each page and filed), examiners should take additional
exam steps to veri@ the call report’s accuracy.
If the credit union lacks a reliable process to ensure call report

accuracy, examiners should take the following additional examination
steps, as necessary, to ensure the accuracy of the call report and
document noted deficiencies in the examination report:
0 Trace the statement of financial condition and income statement

information to source documentation;
0 Trace reported delinquency to information system-generated
reports, if available, including mortgages and credit cards
maintained by a third party data processor;
Review the accuracy of uninsured shares documentation;
0 Trace investments to reports received from outside parties (i.e.,
broker, corporate credit union, etc.), ensuring that reported
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EXAMINER’S GUIDE
investments appear in the appropriate time periods based on the

call report instructions;
Trace loan information to the information system-generated
reports, if available (manual systems may require that examiners
count the loans and trace the number to reported loan information);
and
0 Trace share information to the information system-generated
reports, if available.
To reflect call report changes in the examination report, examiners

must upload any material changes to the call report and request a new
corrected download.
Offsite reviews of quarterly call reports will not allow the examiner the
level of detail described above. Examiners should use other tools such
as the 5300 Cycle-to-Cycle Comparison Report or the Consolidated
Balance Sheet report trends to identify any fluctuations or adverse
trends, making and uploading corrections as necessary. Examiners
should report inaccuracies in the examination report at the next
examination.
Examination Examination planning will assist the examiner in assessing a credit

Planning union’s risk profile and developing a workable risk-focused
Activities examination scope. This scope will enable the examiner to identify
and examine those areas that represent potential, material risk to the
credit union’s capital, earnings, or ability to continue as a going
concern. These tools will enable examiners to estimate the time needed
for performing the risk assessment and anticipate the need for
participation by specialists andor subject matter examiners (SMEs).
After consulting with their supervisory examiners, examiners-in-

charge should request assistance from a SME, if potentially significant
risk exists in an area of the SME’s experience. Examiners may also
choose to use a SME if they are unable to quantify the risk, or if a
material risk exists in an area of proven or emerging concern to
NCUA. When planning the scope of the next examination, examiners
will, when necessary, request participation of a SME. They may also
make such a request if supervision contacts reveal material risk that
requires the skills of a SME. Obviously, SMEs cannot participate in all
Page 1-18
supervision concerns. As with all of NCUA’s resources, a SME’s

participation and the degree of that participation should correlate with
the significance of the overall risk to the NCUSIF presented by the
credit union in question.
Examination planning tasks may include:
Reviewing the prior examination report to identi@ the credit

union’s highest risk areas and areas that require examiner follow
UP;
Analyzing 5300 Call Report and Financial Performance Report

(FPR) trends, using tools such as the following:
- 5300 Cycle-to-Cycle Comparison Report - compares the prior

examination quarter-end data to the current quarter-end data;
and
- Current (and possibly previous) quarter-end Consolidated
Balance Sheet (CBS) report trends;
Reviewing the Scope Workbook to identify prior risk assessment,

recommended areas of review, resource needs, and supervision
plans;
Requesting an organizational chart of the credit union by division

or department, along with a list of committees;
Scheduling interviews with the credit union’s management staff in

key operational areas, including the CEO, Internal Auditor, staff
involved in planning (strategichusiness plans); and
Requesting (and scheduling, if necessary) a meeting with the

supervisory committee and/or external auditors to discuss the audit
and verification processes (in some instances, telephone or email
contacts may suffice).
If examiners cannot schedule a separate onsite planning contact, they

should complete onsite planning at the beginning of the examination.
Although examiners normally perform the following tasks onsite,
circumstances (e.g., distance to the credit union, scheduling conflicts,
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EXAMINER'S GUIDE
or other considerations) may require the examiner to conduct the

activities offsite, using telephone, mail, fax, or electronic mail. These
onsite planning tasks include:
Interviewing key management staff about various topics including

new products and services and future plans for new products and
services;
Reviewing management's due diligence process for a new activity;
0 Reviewing the annual audit workpapers and the audit plan (see the
Supervisory Committee chapter), communicating audit work
performed in pre-determined, high risk areas to the appropriate
team members;
Reviewing the list of internal audits completed to date and the

internal audit planning matrix for the year, identifying internal
audit reports needed by team members for review at the onset of
their examination work;
0 Reviewing the strategichusiness plan;
Reviewing the budget and assumptions;
0 Reviewing the board minutes:
- Identifying discussions about potential risk areas and

discussions about website problems, products, services, and
planned changes to those products and services; and
- Identifying revisions to applicable policies and associated

changes in practices;
0 Reviewing recently adopted new policies and revisions to policies

and procedures, providing the information to the team examiners
assigned to the various risk areas; and
Reviewing other applicable internal credit union documents, such

as material contracts, engagements, pending litigation, new field of
Page 1-20
membership (FOM) groups, website changes, or other operational

change documents.
After developing a preliminary risk-focused examination scope, the

examiner-in-charge should communicate scope information to the
appropriate team members, including expansion or contraction of
applicable areas determined through the supervision process.
The risk-focused examination process should determine the adequacy

of internal controls and the degree of reliance on the work efforts
completed by competent, professional individuals and documented in
reports and audits. Examiners should strive to avoid repeating the work
of these professionals (e.g., internal audit reports, CPA audit
workpapers, board meeting discussions, etc.) Examiners may identify
new areas of risk throughout the contact; therefore, the examiner-in-
charge should remain flexible and adjust the preliminary scope as
needed.
5300 Risk Examiners can use the 5300 Risk Parameters tool (Tab D in the Scope
Parameters Workbook) to assist in the offsite monitoring. Use of this tool aids the
examiner in the evaluation process; however, examiners must use their
judgment. The 5300 Risk parameters is only an indicator of risk; it
does not supercede the examiner’s judgment.
The 5300 Risk Parameters assists examiners in directing what areas

they will focus on during their onsite work. Although the indicators
may indicate a certain level and direction of risk, examiners should,
nevertheless, determine the internal controls, policies, and procedures
in that area. The accuracy of the 5300 Risk Parameters directly relates
to the accuracy of the 5300. Examiners must review the accuracy of
the 5300 as a required examination step. This step will help ensure the
accuracy of the 5300 Risk Parameters reports.
The 5300 Risk Parameters is an intuitive, user-friendly tool and

provides the following:
0 An indication of potential risk - assessment of risk requires review

and judgment; and
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EXAMINER'S GUIDE
0 Information on the direction of risk - the 5300 Risk Parameters

gives an indication of how the risk changed over time.
The 5300 Risk Parameters does not:
0 Assess risk - financial stability does not mean the credit union has
no exposure to current or future risk;
0 Predict future problems - the 5300 Risk Parameters provides an

indicator of current or potential problems, but it does not predict
future problems;
0 Supercede examiner judgment - examiner judgment drives

examination and supervision efforts;
0 Specify examination procedures - using their knowledge of

objective data and subjective factors, examiners must use their
discretion in determining what procedures they do and why they do
them; or
0 Serve as a sole scope determinant - examiners must use their

judgment to evaluate the various information and data, determine
where to expand their analysis, and move on to another area when
sufficient risk does not exist.
CyCle-tO-CyCle The Cycle-to-Cycle Comparison Program (CCCP) enables examiners

Comparisons to compare current cycle 5300 financial and statistical data with data
from any prior cycle within the previous five years. Examiners can
scan the line item results and quickly identify significant changes.
CCCP can help alert examiners to adverse or unusual trends while they
review the data for accuracy.
Consolidated The Consolidated Balance Sheet (CBS) is an Excel spreadsheet that

Balancesheet provides detailed financial information derived from 5300 Call Report
data. Examiners may request a CBS for an individual credit union, a
specific peer group, state, region, asset range, or group of charter
numbers for comparison purposes. Other selection criteria include
federal credit unions (FCU), federally insured, state chartered credit
Page 1-22
unions (FISCU), non-federally insured credit unions (NFICU), limited

income credit unions, type of membership (TOM) code, and cycle
date.
Examiners request a CBS using the Custom Application program

called CBS Request. To request a CBS for a specific credit union,
examiners must input the charter number and cycle date. Upon request,
the data processing server sends the CBS to the examiner in a
spreadsheet format using email. The program contains a “help menu”
that explains its operation.
The CBS ratio analysis looks similar to that of the Financial

Performance Report; however, the CBS provides more detailed
balance sheet, income statement, and supporting schedules. In addition
to the ratios and trends provided, examiners can perform additional
calculations and more in-depth analyses using Excel functions.
Documenting Examiners should document supervision plans for the credit union in
Supervision the Scope Workbook and follow regional procedures for consulting
Plans with their supervisory examiners. They should update the Scope
Workbook after supervision contacts, if necessary. Examples of
documentation for supervision plans include:
0 Type and timing of supervision and examination contacts;

0 Brief description of the areas of risk focus for review during the
contacts; and
0 Staffing recommendations for supervision and examination
contacts.
Examiners will complete the Scope Workbook during each

examination, documenting the severity and direction of risks found
during the examination, and revise the plans when supervision efforts
indicate the need for a change. This workbook will serve as the starting
point for future supervision efforts. The examiner will update the
workbook, as necessary, throughout the year.
The extent of the supervision plans depends largely on the severity and
direction of the risks in the credit union’s operation and on
management’s ability to manage those risks. The examiner’s
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EXAMINER’S GUIDE
professional judgment is paramount in determining the degree of

supervision necessary and the form the supervision efforts will take.
Documenting Changes in the economy, regulatory environment, financial industry,

Changes in Risk global and local events, and numerous factors within the credit union
Profile and itself can affect credit unions, thus, a credit union’s risk profile may
Supervision
change between examinations. The supervision process encourages the
Plans
examiner to identify those changes in profile through the following:
0 Review of 5300s;
0 Communication with credit union staff; and
0 Knowledge of current events affecting the credit union (e.g., new
regulations, investment broker concerns, etc.).
When examiners become aware of information that affects a credit

union’s profile (i.e., a change in the level of one or more of the risk
categories), they should record that risk level adjustment in the Scope
Workbook. The change in the risk profile will likely result in a change
to supervision plans. The examiner should record the revised
supervision plans in the Scope Workbook. Updating the Scope
Workbook allows NCUA to have a current depiction of individual,
regional, and national risk levels on any given date. It also facilitates
the transfer of information when a region transfers a credit union from
one examiner district to another.
Examiners can use the Scope Workbook in conjunction with either

onsite or offsite contacts. They should update it as frequently as
necessary to reflect a credit union’s current risk assessment and their
current plans for supervision. In most credit unions, examiners will
complete the Scope Workbook only during examinations; however,
volatile conditions in credit unions may require more frequent updates
to record the changes in risk levels.
SUpeWiSiOn Examiners cannot separate effective supervision from effective district

and District management. They must know their district credit unions and provide
Management the supervision needed, in their professional judgment, to identify and
address high-risk and potentially high-risk situations.
Page 1-24
The risk-focused program involves both of the following:
0 Risk-focused examinations; and

0 Risk-focused district management.
Examiners have both the authority and the responsibility to manage

their own districts. This suggests that examiners establish sufficient
rapport with their credit unions so that the credit unions will openly
communicate with the examiners about issues and conditions that
develop between onsite contacts. Initiation of this communication can
reside with either the credit union officials or the examiner, when
available information and data indicate the prudence of such a contact.
Successful supervision involves resolving current problems and

avoiding future ones. District examiners must provide a credit union
the attention it needs to identify and reduce risk and to fully resolve
problems. Examiners may determine that some credit unions require
frequent contacts to correct the problems, while monitoring 5300
reports may suffice for others. Credit unions with more serious
problems may require in-depth monitoring of financial trends.
Additionally, effective supervision in a risk-focused environment

means that examiners look beyond the risk in one credit union at a
time. They should also be conscious of systemic risk to the NCUSIF.
This involves informing the regional office, through their supervisory
examiner, when they observe negative effects caused by similar risk
(e.g., a “bubble” in the real estate market, risky lending or investment
issues, concentration issues, vendors that lack appropriate “due
diligence” processes) in several of the credit unions in their district.
su pewision Examiners expect that successhl supervision will result in better

of CAMEL 3, identification of risk and the direction of risk, and prompt
4, and 5 reclassification to a less severe CAMEL code, but supervision can also
Credit Unions result in merger, liquidation or assistance to a credit union. To ensure
the prompt, effective correction of problems, the examiner who
identified the problems and developed plans for corrective action
should maintain supervisory responsibility, unless the region transfers
the credit union to Special Actions. Whenever possible, the examiner-
Page 1-25
EXAMINER'S GUIDE
in-charge should take responsibility for the credit union's supervision

through the next examination.
Effective supervision of credit unions coded 3, and 4 (credit unions

coded 5 normally do not survive) ensures the long-term viability of the
credit unions and ongoing service to members by resolving areas of
concern and reducing levels of unacceptable risk. If the credit union
has risks it cannot manage, or that cause the credit union to fail,
effective supervision minimizes the costs to members, creditors, and
the NCUSIF. The following parameters govern supervisory efforts in
code 3,4, or 5 credit unions:
0 Code 3 credit unions. The examiner provides Code 3 credit unions

with necessary supervision to assist them in improving their
operations and condition.
0 Code 4 credit unions. If appropriate, NCUA may issue Code 4

credit unions an LUA. The examiner performs supervisory contacts
with the purpose of upgrading a Code 4 within 24 months, 12
months being the goal.
0 Code 5 credit unions. By definition, a Code 5 credit union will not

survive more than 12 months, is clearly insolvent, and the
examiner has documented all efforts to save it. Once coded a 5 ,
NCUA will merge, liquidate, or provide other assistance to the
credit union expeditiously. The goal for resolution is six months
from the assignment of the Code 5 and the performance standard is
12 months.
During supervision in code 3,4, or 5 credit unions, the examiner

should perform the following, as necessary:
0 Review previously identified risk areas to determine whether the

direction of risk has decreased or remains unchanged;
0 Determine the progress made in resolving problems;
0 Determine whether the Document of Resolution developed for the

credit union is working, and revise the plan with the officials if
changes would likely resolve the problem;
Page 1-26
0 Inform the board of directors of inadequate progress and the status

of risk areas;
0 Analyze emerging financial trends and risk areas that could

threaten the credit union's solvency;
0 Determine the credit union's economic viability and, where

necessary, explore merger and liquidation alternatives;
0 Recommend administrative actions, when necessary, to protect the

interests of the members, the creditors, and the NCUSIF;
0 Revise, as necessary, the Scope Workbook, future supervision

plans, and the schedule for the next examination; and
0 Review and revise, if necessary, recommendations for team

participants and subject matter examiners.
Administrative Although the risk-focused examination includes few required

Record workpapers, in credit unions coded 3,4, and 5, examiners must
include sufficient workpapers and documentation to establish an
administrative record, should administrative or legal actions become
necessary. The administrative record is the total collection of
information NCUA needs for decision-making purposes. Therefore,
the record should present a complete, factual, and documented history
of the credit union's problems and the attempts by NCUA and the
credit union to resolve them.
Page 1-27
Chapter 2
SCOPE DEVELOPMENT AND PLANNING

TABLE OF CONTENTS
SCOPE DEVELOPMENT AND PLANNING................................................................ 2. 1

Scoping and Planning Objectives ........................................................................ 2-1
Overview .............................................................................................................. 2. 1
Scope Development ............................................................................................. 2. 1
Prior Examinations and Supervision Recommendations......................... 2.2
Preliminary Risk Assessment................................................................... 2-2
Internal and External Factors ................................................................... 2-3
Discussions with Credit Union Management .......................................... 2-4
Team Examinations ............................................................................................. 2-7
. .
Scope Determlnatlon............................................................................................ 2-10
Process or Transactional Review ............................................................. 2-10
Level of Risk ........................................................................................... 2-10
Adjusting the Scope ................................................................................. 2-10
Minimum Procedures............................................................................... 2-11
Documenting the Scope ........................................................................... 2-11
Final Risk Assessment ......................................................................................... 2-12
Budget and Plans...................................................................................... 2-12
ATTACHMENT 2.1 - Risk Indicators ................................................................ A2.1
Credit
Interest Rate
Liquidity
Transaction
Strategic
Reputation
Compliance
Chapter 2

Scoping and 0 Make a preliminary assessment of expected risk
Planning 0 Determine appropriate planning activities
Objectives 0 Evaluate information to assign a level of risk for each risk category
0 Indicate anticipated direction of risks
0 Determine appropriate examination steps and procedures
0 Assess examination resource needs
Overview Effective allocation of resources in a risk-focused program requires

that examiners clearly identify areas where a greater potential for loss
exists. Examination scope describes the type and depth of review
conducted within each risk area during a credit union examination.
Risk areas can vary between examinations. Therefore, examiners must

document the examination scope to support the degree of review for
specified areas. The Scope Workbook is the tool used to document the
scope and risk assessment. This workbook serves as the examiner’s
documentation for the following:
0 Preliminary risk assessments and supporting factors;

0 Areas reviewed, depth of review, and reasons for review;
0 Adherence of examination to regulatory compliance;
0 Final risk assessments and supporting factors;
0 Anticipated direction of risk over the next examination cycle;
0 Estimates for resource needs over the next examination cycle; and
0 Recommendations for future areas of review and supervision plans.
Scope The scope development process enables examiners to evaluate unique

Development characteristics of each credit union and determine what steps the
examination will require. Planning activities will allow the examiner to
draw more informed conclusions regarding the existence of risk. The
Scope Workbook records focal points of the examination.
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EXAMINER’S GUIDE
The risk-focused examination approach requires determination of the

scope through a process involving:
0 Recommendations from the prior examination and supervision

contacts;
0 Preliminary risk assessment;
0 Consideration of internal and external factors;
0 Discussions with credit union management; and
0 Evaluations of the credit union’s control environment and risk
management systems.
Prior Reviewing the prior examination report and recent Scope Workbook
Examination (or history of Scope Workbooks, if significant developing trends exist)
and assists the examiner in preparing for the current examination. The
Supervision
examiner should pay close attention to the risk assessment and
Recommend-
ations recommendations for areas of review.
Pre1imi nary After evaluating the recent Scope Workbooks, examiners will make a
Risk preliminary assessment of the risk they expect to find while
Assessment performing the examination. This assessment includes the following:
0 Analyzing recent call report data;

0 Comparing prior recommendations with recent financial trends;
and
0 Evaluating the credit union’s risk profile.
The examiner will assign a preliminary risk assessment for each of the
seven risk categories: Credit, Interest Rate, Liquidity, Transaction,
Compliance, Reputation, and Strategic. (The Risk-Focused Program
chapter provides more information for identifying the seven risks.)
Quantitative data and any information the examiner has prior to
conducting planning and scoping activities serve as determinants for
this assessment. Information obtained through discussions with
management and findings identified during the field work may change
these preliminary assessments.
Reasons for documenting these preliminary assessments include:
Page 2-2
0 Demonstrating the examiner’s thought process from beginning to

end;
Supporting requests for additional resources; and
0 Supporting use of significant resources or transaction testing even
though the final assessment may indicate low risk.
The 5300 Risk Parameters (found within the Scope Workbook) is a

tool for examiners to use during their initial risk assessment. This tool
provides information on the direction of risk and acts as an indication
of potential risk. It does not predict future problems and does not
supercede the examiner’s judgment in assessing risk. It simply serves
as one of the tools available to assist the examiner in this process.
Other analysis tools available outside of the Scope Workbook include
the Consolidated Balance Sheet program, the Cycle to Cycle
Comparison program, regional and national risk reports.
Internal and If applicable, examiners should consider the following factors, using
External the information obtained to mitigate or amplify the initial risk
Factors assessment:
0 The size and sophistication of the credit union’s operation.

Examiners should identify the significant activities and all major
programs or services offered, including off-balance sheet activities
and other proposed ventures; and
0 Information necessary to focus the examination scope and

maximize the efficiency of onsite examination work. As needed,
examiners should review the following sources of information, if
available:
- Previous examination reports, supervision contacts, and results

of any special targeted examinations occurring since the last
contact;
- Auditors’ reports (both internal and external) and management
letters;
- Management’s response to audit and examination reports;
- Prior examination work papers (paying attention to the depth
and breadth of review in each area). Consider the credit union’s
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EXAMINER'S GUIDE
level of service (e.g., member business loans, real estate loans,

indirect lending);
Correspondence files;
Financial Performance Reports (FPRs);
Call reports and recent financial statements;
Risk management reports;
Income and expense budgets and projections;
Balance sheet (financial) management policy and philosophy;
Internal management reports;
Board of director's packages;
Business, strategic, and marketing plans;
Asset-liability management (ALM) models, policies, and
interest rate risk reports;
Evidence of management due diligence for existing and
anticipated products, services, and systems;
Internal control structure and process;
Credit union service organization (CUSO) activities;
Data processing system and the availability of the automated
integrated regulatory examination system (AIRES) download;
Delivery channels (web-sites, home banking, bill payment
services, automated clearing house (ACH)), etc.);
Sponsor newsletters or news articles;
Economic environment (locally, regionally, and nationally);
and
Recent regulatory changes.
Discussions After establishing a preliminary risk assessment and evaluating

with Credit internal and external factors, the examiner conducts discussions with
Union credit union management, preferably onsite. Practical considerations
Management
(distance to the credit union, schedules of the examiner and manager,
etc.) may mandate a telephone or email contact, which can accomplish
the intended purpose. However, examiners may find an onsite contact
especially important for more sophisticated credit unions with complex
services and products. If examiners-in-charge do not schedule an early
onsite visit, they should obtain as much information as possible
through questionnaires, telephone, email or other contacts. These
discussions enable examiners to develop their own assessments of
current examination risk by refining the initial risk assessments.
Page 2-4
Discussions with management should focus on changes to

management, policies, strategic direction, management information
systems, management due diligence, staff turnover, and other
significant activities occurring since the last examination or
supervision contact. This contact allows the examiner to obtain
management’s perspective about economic conditions, internal and
external audit programs, and the risk management process. The
examiner controls the timing of the contact and should schedule it
close enough to the examination to ensure the information discussed
remains relevant and usable for the examination.
The examiner should make every effort to obtain the following

information regardless of whether an onsite or offsite contact occurs:
0 Economic conditions that have a direct or indirect impact on the

credit union’s overall financial condition. Discussions with senior
management may include the following issues:
- Field of membership, including the principal types of

businesses within the field of membership and plans for hture
expansion;
- Sponsor relationships or special relationships with operating
subsidies that may affect interpretation of comparative data;
- Trends of the credit union’s local economy and stability of
major select groups within the field of membership; and
- Dependence upon a particular industry or economic sector
(e.g., oil and gas, agriculture.)
0 Operational and functional changes. The credit union may

experience, or management may anticipate, changes in the
following areas:
- Overall objectives or management philosophy;

- Senior management, the board of directors, official committees,
or key operating staff;
- Types of loans offered and material changes in loan types and
volume;
- Types of shares offered and material changes in share types and
volume;
- Investment strategies or brokers;
Page 2-5
EXAMINER’S GUIDE
- Liquidity position;
- Operations, including information systems;
- Policies and procedures;
- Formal committee structures; and
- Risk areas posing the highest risk to the operation currently and
in the fbture.
0 Internal control risks identified by the internal or external audits,

the previous examination, verification of members’ accounts or
through other reports should prompt examiners to do the following:
- Consider the following when reviewing the findings of the

internal auditor or personnel responsible for evaluating internal
controls:
i. Independence and experience of personnel conducting

internal control reviews, adequacy of staff size,
appropriateness of audit schedule, and sufficiency of
scope;
..
11. Reliability and effectiveness of internal control reviews;
...
111. Quality of audit reports, and management’s
responsiveness to auditors’ findings;
iv. Quality of internal audit work papers; and
v. Procedures for internal audit reporting;
- Consider reviewing the external auditors’ workpapers if the

following risk-related circumstances exist:
i. Internal control weaknesses;

..
11. Substantial exposure to high-risk activities; and
iii. Past problems with the quality of the audit or audit firm;
and
- Consider the internal controls surrounding the verification of

members’ accounts and the quality of the verification.
0 Assessment of the quality of management. Examiners may wish to

consider the following:
Page 2-6
Findings from prior examinations and CAMEL coding of

Management;
Changes since the last examination in key management
officials;
Activities of the board and other committees including their
degree of activity and participation;
Education and experience of senior management and key
officials;
Performance evaluation system or process;
Organizational chart;
Quality of written policies and procedures;
Quality of the budgeting and planning processes;
Member service and membership recruitment;
Quality of management due diligence, including cost-benefit
studies, for existing or planned products, services, and systems;
and
Adherence to policies and procedures by staff.
Examiners’ past experience and knowledge of the credit union will

affect the amount of time devoted to the scoping and planning phase.
Generally, examiners will spend more time and effort on planning for
larger than for smaller credit unions. However, asset size alone does
not determine the extent of the scope. Examiners must consider the
nature of the credit union’s services, compliance history with those
services, changes in the regulatory environment, and safety and
soundness implications.
For larger and more sophisticated credit unions, early review will
allow examiners-in-charge greater flexibility in determining necessary
resources, including the number, experience, and qualifications of
team members.
Team The supervisory examiner and district examiner schedule team

Examinations examinations according to regional policies. In addition to reviewing
team participants’ workpapers, analyzing the credit union’s
performance, and meeting with the officials, the examiner-in-charge
coordinates, monitors, and facilitates the smooth completion of the
examination.
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EXAMINER'S GUIDE
If needed, the examiner-in-charge and selected team members should

begin the examination before the full team arrives, unless travel and
time considerations preclude an advance team contact. Examiners can
lose substantial time during the initial phases of the examination
waiting for credit union staff to provide data downloads or loan files.
When examiners-in-charge schedule a subject matter examiner or

regional specialist to participate on the examination, they should
schedule these examiners first to ensure their availability when needed
during the examination. The examiner-in-charge should also consider
the amount of time these individuals might need to provide training to
other team members during their onsite work.
The examiner-in-charge (or advance team) should complete the

following steps before the full team's arrival:
0 Contact key officials to inform them of the examination and its

probable duration. Examiners-in-charge that plan to hold a joint
conference should determine a mutually agreeable date and time
(see the Joint Conference/Exit Meeting chapter of this Guide);
Arrange working space for the team;
0 Obtain the supervisory committee work and schedule a meeting

with the auditor, if necessary;
0 Obtain all relative board policies scheduled for review;
0 Select loans for review, as appropriate. Since examiners-in-charge

usually request that credit union employees pull the loan files, they
should give staff as much time as possible before the arrival of the
full team;
Scan board, executive, ALCO minutes, etc., as appropriate;
0 Allocate work assignments to team members. The AIRES Team

Examination option gives the examiner-in-charge the ability to
import and export loan lists, reports, general ledger worksheets
(except balance sheet and income statements) and questionnaires to
and from various team members;
Page 2-8
Provide significant portions of the prior examination to the

appropriate team members, if possible. The examiner-in-charge
often assembles appropriate workpapers, policies, questionnaires
and instructions for team members responsible for specific areas of
the examination; and
Notify team members of their assignments before beginning the

onsite examination to allow the team time to review their assigned
areas and to assemble needed reference material. The examiner-in-
charge will then have the freedom to more effectively coordinate
and direct the overall examination.
A primary goal for the examiner-in-charge’s planning work, after

outlining the scope, is to communicate information gathered from the
process to the applicable team members. The risk-focused examination
process avoids repeating the work already completed by competent,
professional individuals and documented in reports and audits.
The examiner-in-charge often holds pre- and post-examination

conferences with either the full team or selected team members.
During pre-examination conferences, the examiner-in-charge can
discuss the credit union’s risk profile, relate problems noted during
prior examinations and supervision contacts, answer team members’
questions pertaining to their delegated areas of responsibility, provide
instructions on communicating with personnel at the credit union and,
in general, plan the work. The examiner-in-charge should provide an
open door of communication throughout the examination, inviting
team members to discuss risk assessment adjustments based on their
field work.
Post-examination conferences have value in the more complex

examinations in which the examiner-in-charge may not have had the
opportunity to become acquainted with all phases of the credit union’s
operations. Team members can brief the examiner-in-charge on
requested areas, provide reports on their areas of responsibility, and
discuss risk assessment adjustments as necessary. The examiner-in-
charge decides whether to hold pre- or post-examination conferences.
Page 2-9
EXAMINER’S GUIDE
The examiner-in-charge should ensure that adequate documentation

exists and all appropriate meetings with credit union personnel have
occurred before team members depart at the end of the examination.
Scope Completing the Scope Workbook will assist the examiner in

Determin- determining and documenting the scope of the current examination.
ation This workpaper uses prior risk assessments and quantitative data from
the most recent call report to highlight areas of concern.
Process or When developing the examination scope, the examiner needs an

Transactional understanding of the difference between “process” and “transaction”
Review examination steps. Process involves the planning, direction, and
control aspects, including management’s reporting of information for a
given area. Transaction involves the actual individual transactions or
records of a credit union.
The risk-focused examination enables examiners to perform a process

review in the credit union’s well-managed areas, without extensive
transaction testing. This type of examination permits examiners to
evaluate the credit union’s process for managing risk, including how
effectively the credit union uses its information systems.
Level of Risk The scope determination process culminates in identifying specific

procedures the examiners will perform during the examination. If
examiners’ preliminary risk assessment indicates an area has high or
moderate risk, they will then determine which procedures will most
effectively evaluate the depth of the risk and result in
recommendations for improvement. If examiners judge an area to
contain low risk, they may choose to perform no procedures or a very
limited process review.
Adj usti ng the The final scope determination relies on examiner judgment. Examiners
Scope should adjust the scope of the examination as appropriate. This will
require the examiners to use sound professional judgment and analysis,
and to maintain open lines of communication with management. A
successful examination requires discussing relevant concerns as they
Page 2-10
arise. The Scope Workbook provides a forum for the examiner to

summarize the scope of the examination and document the areas
reviewed.
Minimum Examiners will evaluate the credit union’s overall risk profile to
Procedures determine most of the procedures they plan to perform during an
examination. However, the examiners must complete the following
three procedures during each examination, regardless of risk:
0 Verify the accuracy of the call report. The steps required to

perform this verification will vary based on the risk characteristics
present in each credit union. Credit unions with multiple internal
control checks in the accounting and reporting areas may require
little verification. In those credit unions lacking an effective system
of internal controls, examiners may need to perform more
extensive testing to satisy themselves as to the accuracy of the
report.
Review the supervisory committee audit and verification. Again,

this review will vary significantly based on the qualifications of the
auditors, the audit findings, the extent of the audit scope, and the
level of oversight provided by the supervisory committee or
internal auditors.
0 Verify compliance with the Bank Secrecy Act (BSA). The Federal
Credit Union Act requires NCUA to determine compliance with
this law during each examination. Part 748 of NCUA’s Rules and
Regulations specifies some of the requirements of this law. The
Compliance chapter of this Guide provides further information on
the BSA.
Documenting Examiner’s discretion determines the extent of documentation.

the Scope Although no specific requirements exist, the documentation should
demonstrate:
0 The extent of procedures and testing performed;

0 Review of regulatory compliance in applicable areas (e.g., if a
credit union grants member business loans, the examiner should
Page 2-1 1
EXAMINER’S GUIDE
evaluate and document compliance with Part 723 of the Rules and
Regulations);
0 Reasons and factors considered in determining areas and extent of
review;
0 Analysis and assessment of risk areas;
0 Conclusions reached and recommendations made; and
0 Adequate support for conclusions and recommendations.
In cases that result in losses or administrative action, the examination

workpapers will lay the groundwork for building an administrative
record.
Final Risk The examiner will evaluate all information gathered to assign a final
Assessment assessment of risk for each of the seven risk categories. Information
obtained during the examination may result in changes to the
preliminary risk assessment.
Each category of risk will receive a risk assignment of high, moderate,

or low, depending on the factors present in the credit union. At the
conclusion of the examination, the examiner will also indicate the
anticipated direction (increasing, decreasing, or unchanged) of the risk
over the next examination cycle. Some factors contributing to this
anticipated direction include the examiner’s expectations regarding:
0 Management’s ability to monitor and control identified risks;

0 Management’s willingness to monitor and control identified risks;
and
0 Anticipated changes in management, services, economic
environment, field of membership, etc.
Attachment 2.1 contains a list of risk indicators for each risk category.
Examiners should use this attachment only as guidance in the
assignment of risk level.
Budget and After conducting the examination, the examiner begins the planning
Plans cycle again by suggesting future review areas and estimating resource
needs for the next examination and interim supervision. The Budget
and Plans section of the Scope Workbook documents these
Page 2-12
recommendations. Examiners should consider the following items

when completing this sheet:
Level of complexity in any given area;

Need for subject matter examiners or regional specialists;
Recommendations for transactional reviews;
Recommendation for risk-based examination scheduling category;
Anticipated changes in field of membership, charter, services,
management, etc.;
Known or expected changes in senior management, board of
directors, official committees, or key operating staff;
Known or expected regulatory changes affecting the credit union;
Known or expected events affecting budgeted hours (merger,
conversion, voluntary liquidation, involuntary liquidation, etc.);
and
Known or expected trends in local and national economy.
When the examiner uploads the scope workbook, the Budget and Plans
section records the hours anticipated for the next examination and
interim supervision. The supervisory examiner will have the
opportunity to review this document as part of the completed
workbook.
Liquidity Risk idicators
Factor Low Moderate High
Board and Fully understands all aspects Reasonably understands key Does not understand, or
Operational of liquidity risk. aspects of liquidity risk. chooses to ignore key
Management aspects of liquidity risk.
Understanding
Management Anticipates and responds Adequately responds to Does not anticipate or take
Responsiveness well to changes in market market condition changes. timely or appropriate actions
conditions. in response to changes.
Liquidity Favorable position with Not excessively vulnerable to Access to funds is impacted
Position and negligible exposure to funding difficulties should an by poor market perception or
Risk Exposure earnings and capital. adverse change in market market resistance, resulting in
perception occur. Earnings substantial exposure to loss
or capital exposure is of earnings or capital.
manageable.
Funding Ample funding sources exist. Sufficient funding sources Funding sources and portfolio
Sources Funding sources provide the exist to provide cost-effective structures suggest current or
credit union with a liquidity. potential difficulty in
competitive cost advantage. sustaining long-term and
cost-effective liquidity.
Borrowing Widely diversified, with little Diversified with few providers Concentrated in a few
Sources or no reliance on wholesale or groups sharing common providers, or providers with
or other credit-sensitive investment objectives and common investment
funds providers. economic influences. objectives or economic
influences.
Future Liquidity Market alternatives exceed Liquidity position is not Liquidity needs may be
Position demand for liquidity with no expected to deteriorate in the increasing with declining
adverse changes expected. near term. medium- and long-term
funding alternatives.
Risk Processes reflect a sound Processes are adequate. Processes are deficient.
Management culture that has proven
Process effective over time.
MIS Reporting Timely, complete, reliable, For the most part, timely, Do not provide useful
and reviewed by complete, reliable, and information for managing
management. reviewed by management. liquidity risk.
Balance Sheet Appropriate attention is given Attention to balance sheet Attention to balance sheet
Management to balance sheet management is appropriate. management is inappropriate.
management and the cost Access to funding markets is Management has not
effectiveness of liquidity properly assessed and realistically assessed the
alternatives. diversified based upon size credit union’s access to funds
and complexity. and has not paid sufficient
attention to diversification.
Contingency Well-developed and Effective and the cost of Nonexistent or incomplete.
Plans effective. liquidity alternatives is Cost of alternatives has not
adequately considered. been adequately considered.
High probability exists that
contingency funding sources
are needed. Improvement is
not expected in the near
future.
Cash Flow Effective, reliable and timely Adequate analysis conducted Analysis not done or is
Analysis analyses are conducted. based upon size and inadequate.
complexity.
Attachment 2.1
d - /7
Transaction R ;k Indicators
Board and Fully understands all aspects
Operational of transaction risk. aspects of transaction risk. chooses to ignore key
Management aspects of transaction risk.
Understanding
Responsiveness Anticipates and responds Adequately responds to Does not anticipate or take
to Market and well to changes. changes. timely or appropriate actions
Technological in response to changes.
Conditions
Risk Exposure Only a slight probability of Possible loss to reputation, Weak internal controls
damage to reputation, earnings or capital exists but expose the credit union to
capital, or earnings. is mitigated by adequate significant damage to
internal controls. reputation, or loss of earnings
or capital.
Transaction History of sound operations. History of adequate History of transaction
Processing Likelihood of transaction operations. Likelihood of processing failures.
Controls processing failures is transaction processing Likelihood of future failures is
minimal due to strong failures is minimized by high due to absence of
internal controls. generally effective internal effective internal controls.
controls. I
Systems and Strong control culture that Adequate operating and Serious weaknesses exist in
Controls results in systems, internal information processing operating and information
controls, audit, and systems, internal controls, systems, internal controls,
contingency and business audit coverage, and audit coverage, or
recovery plans that are contingency and business contingency and business
sound. recovery plans are evident. I recovery plans.
MIS Satisfactory Minor deficiencies may exist I Significant weaknesses in
that relate to transaction and transaction and information
information processing processing activities.
activities.
New Products Favorable performance in Planning and due diligence Inadequate. CU is exposed
or Services expansions and introductions prior to introduction of new to risk from the introduction or
of new products and services are performed expansion of new products
services. although minor weaknesses and services.
exist.
Conversion Conversion plans are clear, Conversion plans are evident, CU may be exposed to
Management comprehensive, and although not always processing risks due to poor
followed. comprehensive. conversion management,
either from the integration of
new acquisitions with existing
systems, or from converting
one system to another.
Problem Management identifies Management recognizes Management has not

Identification weaknesses quickly and weaknesses and generally demonstrated a commitment
and Corrective takes appropriate action. takes appropriate action. to make the corrections
Action required to improve
transaction processing risk
controls.
Attachment 2.1
Strateaic Risk Indicators
Risk Management Practices are an integral Quality is consistent with the Practices are inconsistent
Practices part of strategic planning. strategic issues confronting with strategic initiatives. A
the credit union. lack of strategic direction is
evident.
Strategic Strategic goals, objectives, Demonstrated the ability to Operating policies and
Planning culture, and behavior are implement goals and programs inadequately
effectively communicated objectives and successful support strategic initiatives.
and consistently applied implementation of strategic The structure and talent of
throughout the institution. initiatives is likely. the organization do not
The depth of management support long-term strategies.
talent enhances strategic
direction and organizational
corporate efficiency.
ManagemenVStaff Changes in key Key management or staff Key management or staff
Turnover management or staff are changes recently occurred. turnover is high and poorly
well managed and minimal. Succession plans are managed. Succession plans
Succession plans are adequate. are non-existent, inadequate,
documented and effective. or ignored.
Track Record Management has been Management has a Deficiencies in management
successful in reasonable record in decision-making and risk
accomplishing past goals decision-making and controls. recognition do not allow the
and is appropriately institution to effectively
disciplined. evaluate new products,
services, or FOM expansions.
MIS Management information Management information Management information
systems effectively support systems reasonably support systems supporting strategic
strategic direction and the credit union’s short-term initiatives are seriouslv flawed
initiatives. direction and initiatives. or do not exist.
Risk Exposure Exposure reflects strategic Exposure reflects strategic Strategic goals emphasize
goals that are not overly goals that are aggressive but significant growth or
aggressive and are compatible with business expansion that is likely to
compatible with developed strategies. result in earnings volatility or
business strategies. capital pressures.
Impact and Risk Initiatives will have a Actual practices have only The impact of strategic
of Initiatives negligible impact on minor inconsistencies with decisions is expected to
capital, systems, or planned initiatives. Initiatives significantly affect net worth.
management resources. are reasonable considering Strategic initiatives may be
The initiatives are well the capital, systems, and aggressive or incompatible
supported by capital for the management. Decisions are with developed business
foreseeable future and not likely to have a significant strategies. Decisions are
pose only nominal possible adverse impact on earnings either difficult or costly to
effects on earnings or capital and can be reverse.
volatility. reversed without significant
cost or difficulty.
Appropriateness New products/services are New products/services will Strategic goals are unclear or
of New Products supported by sound due not materially alter business inconsistent, and have led to
& Services diligence and strong risk direction, can be an imbalance between the
management. The implemented efficiently and credit union’s tolerance for
decisions can be reversed cost effectively, and are risk and willingness to supply
with little difficulty and within management‘s abilities. supporting resources for new
manageable costs. productlservice offerings.
Attachment 2.1
-Reputation Ri!
I Factor
Operational
Management
Response to
Organization
and Overall
Operations
Risk
Management
Internal
Controls and
Audits
[ Indicators
Low
Anticipates and responds
well to changes of a market
or regulatory nature that
impact its reputation in the
marketplace.
Management fosters a sound
culture that is well supported
throughout the organization
and has proven very
effective over time.
The credit union effectively

self-polices risks.
Fully effective.
Moderate
Adequately responds to
changes of a market or
regulatory nature that impact
the institution’s reputation in
the marketplace.
Administrative procedures
and processes are
satisfactory. Management
has a good record of
correcting problems.
The credit union self-polices

risks.
Generally effective.
High
Does not anticipate or take
timely or appropriate actions
in response to changes of a
market or regulatory nature.
Weakness may be observed

in one or more critical
operational or administrative
activities. Management
information at various levels
exhibits significant
weaknesses.
The credit union’s
performance in self-policing is
suspect.
Not effective in reducing
exposure. Management has
either not initiated, or has a
poor record of, corrective
actions to address problems.
Net worth is only minimally The exposure of net worth Net worth is substantially
Exposure exposed by reputation risk. from reputation risk is exposed by reputation risk
Minimal member complaints controlled. Adequate shown in significant litigation,
received, involving minor systems exist to process large dollar losses, or a high
issues. Complaints are member complaints volume of member
handled promptly, effectively, satisfactorily. complaints. The potential
and efficiently. exposure increases with the
number of accounts, the
volume of assets under
management, or the number
of affected transactions.
Legal Risk Losses from fiduciary The credit union has avoided Poor administration, conflicts
activities are low relative to conflicts of interest and other of interest, and other legal or
the number of accounts, the legal or control breaches. The control breaches may be
volume of assets under level of litigation, losses, and evident.
management, and the member complaints are
number of affected manageable and
transactions. The credit commensurate with the
n
union does not regularly volume of business
experience litigation or conducted.
member complaints.
Disaster Documented, tested, and Adequate plans are in place. Inadequate or non-existent
Recove Plans effective plans are in place. plans.
Promotional and Effective promotional and Adequate promotional and Inadequate or non-existent
Educational educational efforts are made educational efforts are promotional and educational
Efforts to reach existing and undertaken. efforts.
potential members.
Attachment 2. I
Comdiance Risk Indicators
Board and Fully understands all aspects Reasonably understands the Does not understand, or has
Operational of compliance risk and key aspects of compliance chosen to ignore, key aspects
Management exhibits a clear commitment risk. Commitment to of compliance risk. The
Understanding to compliance. Commitment compliance is reasonable and importance of compliance is
is communicated throughout satisfactorily communicated. not emphasized or
the institution. communicated throughout the
organization.
Authority and Authority and accountability Authority and accountability Management has not
Accountability for compliance are clearly are defined, although some established or enforced
defined and enforced. refinements may be needed. accountability for compliance
performance.
Response to Anticipates and responds Adequately responds to Does not anticipate or take
Changes well to market or regulatory market or regulatory changes. timely or appropriate actions
changes. in response to market or
regulatory changes.
Product and Compliance considerations While compliance may not be Compliance considerations
Systems are incorporated into product formally considered when are not incorporated in
Development or systems development. developing product or product or systems
systems, issues are typically development.
addressed before they are
fully implemented.
Violations & Violations, noncompliance, The frequency or severity of Violations, noncompliance, or
Risk Exposure or litigation are insignificant, violations, noncompliance, or litigation expose the credit
as measured by their litigation is reasonable. union to significant
number or seriousness. impairment of reputation,
value, earnings, or business
opportunity.
Error Detection When deficiencies are Problems can be corrected in Errors are often not detected
and Corrective identified, management the normal course of internally, corrective action is
Action promptly implements business without a significant often ineffective, or
meaningful corrective action. investment of money or management is
management attention. unresponsive.
Management is responsive
when deficiencies are
identified.
Risk Good record of compliance. Compliance management Compliance management
Management The CU has a strong control systems are adequate to systems are deficient,
culture that has proven avoid significant or frequent reflecting an inadequate
effective. Compliance violations or noncompliance. commitment to risk
management systems are management.
sound and minimize the
likelihood of excessive or
serious future violations.
Controls and Appropriate controls and No shortcomings of The likelihood of continued
Systems systems are implemented to significance are evident in violations or noncompliance
identify compliance problems controls or systems. The is high because a corrective
and assess performance. probability of serious future action program does not
violations or noncompliance exist, or extended time is
is within acceptable needed to implement such a
tolerance. program.
Training and Training programs are Management provides Management has not
Resources effective and the necessary adequate resources and provided adequate resources
resources have been training given the complexity or training.
provided to ensure of products and operations.
compliance.
Attachment 2.1
Chapter 3
TOTAL ANALYSIS PROCESS

TABLE OF CONTENTS
TOTAL ANALYSIS PROCESS...................................................................................... 3-1

Examination Objectives ....................................................................................... 3.1
Overview.,............................................................................................................ 3.1
Collecting Data .................................................................................................... 3-2
. .
Reviewing Data .................................................................................................... 3-2
Levels of Analysis................................................................................................ 3-3
Structural Analysis ................................................................................... 3.3
Trend Analysis ......................................................................................... 3.6
Reasonableness Analysis ......................................................................... 3.6
Variable Data Analysis ............................................................................ 3-7
Qualitative Data Analysis ........................................................................ 3-8
Interpreting Data .................................................................................................. 3-9
Reaching Conclusions.......................................................................................... 3-9
Making Recommendations .................................................................................. 3.10
Developing Plans for Action ................................................................................ 3. 10
Testing the Results ............................................................................................... 3. 11
Workpapers and References................................................................................. 3. 11
Chapter 3

Examination Evaluate the components of CAMEL
Objectives 0 Review quantitative measurements
0 Review qualitative considerations
0 Interpret examination results and reach conclusions
0 Recommend and help develop action plans
Overview The CAMEL Rating System provides an accurate and consistent

assessment of a credit union’s financial condition and operations in the
areas of Capital Adequacy, Asset Quality, Management, Earnings, and
AssetlLiability Management. This internal tool measures risk and
allocates resources for supervision purposes. Examiners can access
NCUA’s most recent Letter to Credit Unions regarding the CAMEL
Rating System in the Letters to Credit Union section of Reference
Information on the NCUA website (www.ncua.gov).
The CAMEL rating culminates the examination process. Key ratios

alone do not automatically determine the rating. Examiners should
look behind the numbers to determine the significance of supporting
ratios and trends. When evaluating the components of CAMEL,
examiners look at the seven risks discussed in the Risk-Focused
Program Chapter the quantitative measurements and the
qualitative considerations outlined in the Letter to Credit Unions
discussed above before determining a final rating. Examiners have the
discretion to increase or decrease any rating they deem necessary using
their professional judgment. They should support increases or
decreases in the examination report.
The total analysis process includes:
0 Collecting data;
0 Reviewing data;
0 Interpreting data;
0 Reaching conclusions;
Page 3-1
EXAMINER'S GUIDE
0 Making recommendations; and

0 Developing plans for action.
Collecting The examiner collects statistical data during the planning phase of the
Data examination. Some financial data appears on the 5300 Risk Parameters
tab of the Scope Workbook, with more detail on the various AIRES
work papers including the Financial History and Key Ratio forms.
Examiners obtain qualitative data by observation (e.g., reading the
minutes, policies, recent correspondence, prior examination reports,
watching as staff performs their duties) and by discussion with
officials and employees. Several examination work papers (e.g., Loan
Exceptions, Examiner Findings, Informal Discussion Items) document
qualitative and quantitative data. The Examination Overview
summarizes the data in a narrative form.
The Financial History, a key form for performing the total analysis
process, compiles examination data for computing ratios on the Key
Ratio Analysis form. For periods other than those on the Key Ratios
form, examiners may collect and analyze date using optional AIRES
work papers or alternative analysis tools like the Consolidated Balance
Sheet or Cycle-to-Cycle programs.
Reviewing The imported data automatically carries forward to Financial History,

Data Key Ratios and various investment, loan, and share reports. The prior
year-end and current quarter-end 5300 information flows from the
Calculated 5300 Accounts spreadsheet to the appropriate forms.
Examiners should verify the integrity of the 5300 data. If the examiner
finds errors on the 5300, they should upload corrected data through the
host system and make corrections during the current examination. The
examiner should also consider requiring that the credit union restate
the appropriate financial statements.
In this portion of the total analysis process, the examiner (1) breaks
down and reassembles the data, relating individual parts to the whole;
(2) notes the trends; and (3) evaluates the data. This complex
evaluation of the examination data requires examiners to use their
professional judgment.
Page 3-2
Levels of Examiner judgment affects the overall analytical process. The

Analysis examiner sets the tone for the data review process by asking
management appropriate questions, and reviewing and completing the
Preliminary Risk Assessment tab of the Scope Workbook. The review
of data takes place in varying levels of analysis, including:
Structural analysis,
0 Trend analysis,
Reasonableness analysis,
Variable data analysis, and
0 Qualitative data analysis.
Numerous ratios measuring a variety of credit union functions provide

the basis for analysis. Examiners must understand these ratios both
individually and as a group, depending on the type of analysis being
performed. For example, some individual ratios may not provide an
accurate picture without a review of the related trends. Analyzed as a
group, however, the ratios may depict important trends not seen when
reviewing individual measures.
Str ucturaI Structural analysis includes the review of the component parts of a
Analysis financial statement in relation to the whole. The examiner analyzes
financial data and the ratios developed from that data. For example, the
return on average assets is a structural analysis ratio developed from
the income and assets.
The examiner should first develop expectations of the relationships of

these financial components or ratios to each other and as a whole. In
developing expectations, the examiner may refer to comparable prior
periods, budgets, industry trends, etc.
The examiner then compares the anticipated results with the

relationships actually taking place among financial elements within the
period. This highlights two important aspects of structural analysis: (1)
structural analysis is static in the sense that the examiner reviews the
composition of the financial statement as of a specific date or as of a
particular cut-off date; and (2) the credit union’s resulting financial
ratios should fall within reasonable parameters or the examiner’s
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EXAMINER’S GUIDE
expectations. Examiners may use the Reasonableness worksheet in the

ExamOptional workbook to assist in making this determination.
One or more ratios outside those reasonable parameters can indicate an

at-risk, misstated, or otherwise suspect financial condition. For
example, consider the close relationship between asset composition
and gross income. If loans comprise 90 percent of a credit union’s
assets and those loans have a 15 percent annual percentage rate (APR)
and nominal loan delinquency, the examiner would expect relatively
high gross income. However, if gross income as a percentage of
average assets equals only 6.9 percent, the results fall outside the
examiner’s reasonable parameters or expectations and should raise
questions that warrant further review.
Additionally, the examination process, while not designed to detect

fraud, may warrant expanded procedures when red flags exist (the
Management and General Ledger chapters and the appendix to the
Share Structure chapter contain red flags.)
When analyzing the financial and operational structure, examiners

should:
0 Step back from examination details and individual ratios (and often
from the computer);
0 Think about the big picture, how the various aspects of the
examination interact and the individual ratios relate to each other;
and
0 Assess management’s ability to identify, measure and control
current and future risk.
The risk-focused examination provides examiners flexibility in the

examination scope (i.e., examiners should expand procedures when
they note high related risks.) For example, if management has a poor
process for managing credit risk, examiners should expand the loan
review. The structural analysis process enables examiners to (1)
analyze internal controls, (2) judge how much reliance they can place
on those controls, and (3) persuade the officials to identify and correct
weaknesses and other conditions conducive to fraud and
embezzlement.
Page 3-4
During structural analysis, the examiner reviews the statistical data on

the AIRES Financial History form and the 5300 Risk Parameters tab of
the Scope Workbook and calculates structural ratios on the Key Ratio
work paper in AIRES. Generally, the examiner uses the key ratios to
evaluate and appraise the credit union’s overall financial condition as
of the examination date. However, examiners may require other
structural ratios to complete the analysis or to corroborate the tentative
conclusions reached after reviewing the required key structural ratios.
The analysis of management’s financial vision includes reviewing key
ratios against the credit union’s projected ratios in the budget or
business plan. Examiners should expand a review when they identify
risk indicators.
To determine the level of risk, examiners review structural ratios

individually and in relation to each other. For example, if a credit
union has a lower than normal net income level, but strong and stable
capital ratios, the examiner may initially suspect that the credit union
has an earnings problem. However, in reality, management may reward
the members with higher dividend rates that do not threaten the credit
union’s strength. In any case, if the credit union has negative year-to-
date return on average assets, the examiner should determine whether
earnings pose a potentially serious problem.
During the structural ratio review, the examiner may carefully compare
the credit union’s ratios to the same ratios of similar size credit unions.
Economic, geographic and other differences between one credit union
and another preclude indiscriminate comparisons. Peer ratios do not
represent standards or goals for the credit union to attain; they serve
only as benchmarks. As such, examiners should use peer ratios as
analysis points only, and should not carry this type of comparison to
the Overview. Examiners should keep in mind a basic tenet of ratio
analysis: ratios never answer questions; they only raise them.
Examiners should not recommend specific action either orally or in the

examination report when the only reason offered is that the credit
union should meet a peer or national average. Pursuing the reasons for
the adverse ratios often allows the examiner to distinguish between
unacceptable risks and appropriate trends for the particular credit
union.
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EXAMINER'S GUIDE
Structural analysis enables examiners to identifj potential risks;

however, examiners need trend analysis, in addition to the structural
approach, to reach appropriate conclusions and make sound
recommendations to management. Trend analysis helps determine the
level and direction of the risk.
Trend Analysis Trend analysis involves comparing the component parts of a structural
ratio to itself over several time periods. Seasonal fluctuations may
warrant the examiner using other than annual trend analysis periods.
While trend analysis often requires looking back at prior ratios, it also
serves as a valuable forecasting tool that allows the examiner or credit
union to project outcomes if the credit union chooses another solution
or resists making needed corrections.
Trend analysis enables identifying, questioning, and evaluating the

changes in results of operations. For example, assume a credit union
has a ratio of delinquent loans to total loans of 10 percent. If the
structural ratio were 5 percent at the previous examination, the
examiner would determine the reasons for the increase by reviewing
the trends of each component, total loans and total delinquent loans.
The increase may result from (1) delinquent loans increasing while
total loans decrease or remain unchanged; (2) both delinquent loans
and total loans increasing, but delinquent loans increase at a faster rate;
(3) both delinquent loans and total loans decreasing, but total loans
decrease at a faster rate; or (4)delinquent loans remaining unchanged
while total loans decrease.
Determining which situation applies provides a basis for expanding the

depth of analysis needed to fully assess the potential risk. During the
total analysis process, examiners should:
0 Determine whether material negative trends exist;

0 Ascertain the action needed to reverse unfavorable trends; and
0 Formulate, with management, recommendations and plans to
ensure implementation of these actions.
Reasonable- As needed, the examiner performs necessary reasonableness tests to

ness Analysis ensure accuracy of financial performance ratios. For example, if the
Page 3-6
cost of f k d s exceeds the average stated rates, the yield on loans in a

highly loaned out credit union with no reported delinquency equals
less than half the stated rate, or the yield on investments falls well
below market in comparison to the balance, the examiner should
determine the cause. AIRES has the capability (optional) to compute
share costs and loan yields within the Critical worksheets for shares
and loans. AIRES also calculates reasonableness ratios on the optional
worksheet, Reasonableness Ratios.
By performing reasonableness tests, the examiner might identify

transaction risks such as (1) unauthorized disbursements, (2) out-of-
balance conditions, (3) negative share accounts (overdrafts), (4)
payment of personal expenses from credit union funds, and (5)
fictitious loan or share accounts (or other fictitious records). The
existence of fraud or embezzlement often causes the financial
performance ratios to fail tests of reasonableness, which may serve as a
red flag indicating the need for more in-depth review by the examiner.
Most individual balance sheet items provide limited usable

information that examiners can retrieve to analyze the credit union's
financial condition. If examiners decide to perform an account
analysis, they must understand what entries make up the whole
account.
Variable Data Examiners can often analyze an examination area in many different
Analysis ways. For example, during the loan review, a variety of options exist
by which examiners may analyze loans, including:
The amount current and the amount delinquent (the amount

delinquent can be further broken down into length of delinquency);
The amount collectible or uncollectible;
The number of loans involved;
The average unpaid balance of each loan;
The loan turnover rate;
The percentage of high risk loans (may require profiling loans);
The amount allocated to a new loan program (e.g., risk-based
lending);
The amount unsecured and secured;
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EXAMINER'S GUIDE
The types of security and the amount secured by each type (e.g.,
co-makers, automobiles, real estate, etc.); and
The appraised or market value of the security compared with the
unpaid balances of the secured loans.
Ascertaining any one of the above remaining items may provide a

basic understanding. Obtaining additional items may allow the
examiner to perform a more meaninghl analysis. Rather than
categorizing each loan, examiners can determine the appraised or
market value of the security using a sampling process.
Likewise, examiners can break down other examination areas (e.g.,

investments, shares, etc.) to facilitate the analysis. The total analysis
process enables examiners to look beyond the "static" balance sheet
figures to more accurately assess the financial condition, quality of
service, and risk potential.
Qualitative Qualitative data includes information and conditions that are not
Data Analysis measurable in dollars and cents, percentages, numbers, etc.
Nevertheless, they have an important bearing on the credit union's
current condition, and will undoubtedly affect its future. Examples of
qualitative data include lending policies and practices, internal
controls, attitude and ability of the officials, risk measurement tools,
risk management, economic conditions within the general economy
and of the sponsoring organization, and attitude of the sponsoring
organization.
In an effective examination, qualitative analysis requires the examiner

to go beyond merely identifying trends and to look for causes behind
the quantitative performance. When events beyond management's
control adversely affect the credit union (e.g., loss of the sponsor,
strike at the sponsor, natural disaster, etc.), the examiner should work
with the officials to develop policies or procedures that will counteract
or lessen unfavorable influences, both internal and external.
The main purposes for reviewing qualitative data are to (1) help
project the credit union's future, and (2) determine the control
environment surrounding various operations. The credit union's future
heavily depends on management's ability to identify, monitor,
Page 3-8
measure, and manage risks. The total analysis process requires the
examiner to perform varying levels of analysis (structural, trend,
reasonableness, variable data, and qualitative) before interpreting the
results of the review.
Interpreting Interpreting the data involves the most complex phase of the total
Data analysis process. The examiner’s ability, judgment, experience and
skill all come into play in this process of questioning the data. If
examiners place too much emphasis on inconsequential facts or
underplay or ignore significant facts, they may arrive at erroneous
conclusions that could harm the credit union. For example, individuals
often charter a credit union primarily to provide loans to members.
Lending programs require that the credit union take a reasonable
business risk, which results in earnings sufficient to maintain or build
net worth. However, by emphasizing zero delinquency and loan losses,
the examiner could diminish a primary reason for the credit union’s
existence and unnecessarily decrease its income. Performing the
following will increase understanding and possibly change the
examiner’s preliminary assessment of risk:
0 Inquire about the sponsor’ssupport and viability, local economic

conditions, and other relevant information not directly available
within the confines of the credit union’s office;
0 Differentiate between important and unimportant data; and
0 Place all data in its proper perspective.
Reaching After collecting, reviewing, and properly interpreting all appropriate

Conclusions data, the examiner arrives at conclusions. In this part of the total
analysis process, the examiner identifies concerns, explains the causes,
and assesses risk to arrive at a CAMEL rating. The examiner will
determine the level (high, moderate, or low) of the overall strategic,
interest rate, credit, liquidity, transaction, compliance, and reputation
risks. The examiner will also evaluate the direction of these risks
(increasing, unchanged, or declining). For example, the examiner may
determine that the member business loan portfolio has high credit risk.
However, member business loans may only make up a small percent of
total assets. As a result, the examiner may conclude that the credit
union has low or moderate credit risk depending on the remainder of
Page 3-9
EXAMINER'S GUIDE
the balance sheet and management's future plans for their member
business loan program.
Depending on a credit union's circumstances and the degree of

examiner judgment required for each case, examiners may find some
conclusions relatively simple to reach, while they find others difficult.
Examiners can make sound recommendations only by reaching
informed and logical conclusions.
Making After analyzing the operation, the examiner makes recommendations

Recommend- for action based on the conclusions reached and final risk assessments.
ations The recommendations usually consist of general statements addressing
what the credit union should do to correct its problems and reduce
unacceptable risk. Examiners should assist the officials in developing a
specific plan for carrying out the recommendation.
DeveIoping Well-designed, achievable, and measurable action plans should reduce

Plans for unacceptable risks and prevent problems from recurring. Since
Action management's responsibility includes implementing the action plans,
the examiner and management should jointly develop the plans. While
examiners usually have an approach for the plan in mind, they should
be tactful, flexible, and receptive to alternatives suggested by
management, who will more likely implement the plan if they
participate in developing it.
Management often corrects less serious weaknesses during the

examination, thus eliminating the need for a formal written plan.
Examiners should document the significant agreed upon action plans,
describing the reasons and causes in the written examination report.
An action plan should specify the following:
0 Who will take the action;

0 Description of the action;
0 Completion dates; and
0 Responsible oversight by the supervisory committee or officials, if
necessary.
Page 3-10
The action plan should remain in effect until the examiner and board
agree the improved financial condition and level of risk reduction
warrants discontinuance or relaxation of the plan. If the credit union
has not made sufficient improvement, the examiner and the board
should strengthen or revise the plan.
Testing the Valid results of the total analysis process depend on the examiner
ResuIts considering and accurately interpreting all pertinent data. The
examiner then has the tools to make meaningful recommendations and
design action plans that will reduce unacceptable risks and prevent
future problems. If examiners have not properly applied the total
analysis process, inappropriate recommendations and action plans may
result. To reduce this possibility, the examiner should:
0 Make a final review of all data;

0 Discuss analysis, risk assessments, and conclusions with
management;
0 Determine that recommendations and action plans are practical,
specific, and understandable; and
0 Determine that the plans will achieve an appropriate level of risk
reduction.
Workpapers 0 Work papers

and - Financial History
References - Key Ratios
- Scope Workbook
- Examination Overview
- Confidential Section
- Supplementary Facts
- Examiner’s Findings
- Financial Triggers Questionnaire
- Document of Resolution
Page 3-11
Chapter 4
INTERNAL CONTROLS
TABLE OF CONTENTS
INTERNAL CONTROLS................................................................................................ 4-1

Examination Objectives ....................................................................................... 4-1
Associated Risks .................................................................................................. 4-1
Overview.............................................................................................................. 4. 1
Safety and Soundness........................................................................................... 4.2
Accurate Financial Statements............................................................................. 4.3
Other Laws and Regulations ................................................................................ 4.4
Internal Control Components............................................................................... 4.4
Control Environment ............................................................................... 4.5
Risk Assessment ...................................................................................... 4-5
Control Activities..................................................................................... 4.5
Control Systems ....................................................................................... 4-7
Self-Assessment or Monitoring ............................................................... 4.7
Internal Control Evaluation.................................................................................. 4.8
Strategic Risk ....................................................................................................... 4-8
Transaction Risk .................................................................................................. 4.9
Compliance Risk .................................................................................................. 4. 10
Reputation Risk .................................................................................................... 4. 10
Workpapers and References................................................................................. 4-12
APPENDIX 4A .Conflicting Management Positions ....................................... . . A.
41
APPENDIX 4B .Information System (IS) Reports ............................................. 4B-1
3.Y3. 3
" w
Chapter 4
INTERNAL CONTROLS
Examination 0 Determine whether the credit union has implemented efficient and
Objectives effective operations and risk management systems
0 Determine whether the credit union accurately records transactions
0 Determine timeliness and reliability of financial reporting
0 Determine whether the credit union complies with regulations,
internal policies, and internal procedures
0 Assess whether the credit union has implemented adequate internal
controls to safeguard assets
Associated 0 Strategic risk occurs when management fails to (1) perform

Risks necessary due diligence as it applies to internal controls
surrounding existing and proposed products and services, (2) act on
recommendations included in examinations and internal/external
audit reports, and (3) allocate the necessary resources to implement
proper internal controls;
0 Transaction risk occurs when internal controls do not sufficiently
deter or detect errors, omissions, or material misstatements;
0 Compliance risk occurs when the credit union fails to adhere to
applicable laws and regulations; and
0 Reputation risk occurs when management fails to meet its fiduciary
duties, resulting in poor publicity or administrative action.
Overview Internal control is defined as a process, developed by a credit union's

board of directors, management, and other personnel, designed to
provide reasonable assurance regarding the achievement of objectives
in the following categories:
0 Effectiveness and efficiency of operations;

0 Reliability of financial reporting; and
0 Compliance with applicable laws and regulations.
Internal control does not guarantee that the entity will achieve its
objectives or even remain in business. Rather, internal control provides
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EXAMINER'S GUIDE
management with reasonable assurance regarding the achievement of

objectives. Inherent limitations to internal control exist and
costhenefit considerations will prevent implementation of all possible
controls. Inherent limitations may also limit the effectiveness of
internal controls.
3 113 of the FCU Act states that the board of directors shall have the
general direction and control of the affairs of the credit union,
including the proper and profitable conduct of credit union operations,
the safety of credit union assets, and the accuracy and adequacy of
financial statements. The board retains overall responsibility for the
affairs of the credit union. As part of that responsibility, the board
establishes internal controls, which include organizational plans,
policies, and operating procedures to maintain control over the duties
delegated to paid employees.
Internal control systems assist management with the following:
0 Measuring performance, making decisions, evaluating processes,

and managing risks;
0 Achieving its objectives and avoiding surprises; and
0 Detecting mistakes caused by personal distraction, carelessness,
fatigue, errors in judgment, or unclear instructions in addition to
fraud or deliberate noncompliance with policies.
Effective and well-designed control systems are still subject to

execution error. In other words, human beings still must execute most
control systems and even well trained personnel with the best of
intentions can become distracted, careless, tired or confused.
Consistent application and thorough understanding of internal control

by credit union personnel can determine the effectiveness of board and
management policies. Controls typically (1) limit authorities, (2)
safeguard access to and use of records and credit union assets, (3)
separate and rotate duties, and (4)ensure both regular and unscheduled
reviews, including testing.
Safety and The FCU Act and the bylaws establish the basic organizational pattern
Soundness for credit unions. A credit union's growth necessitates further divisions
Page 4-2
INTERNAL CONTROLS
of duties and responsibilities. The following organizational procedures

enhance the attainment of internal control:
0 Approval of loan applications by a separate credit committee

elected by the members or appointed by the board, or by a loan
officer appointed by the credit committee or the board;
0 The signing and countersigning of checks and notes by a person

other than a disbursing officer;
0 Approval of membership applications by the board, executive

committee, or membership officer, rather than by the paid board
officer, the financial officer, any assistant to the paid board officer
or financial officer, or a loan officer;
0 Internal audits by the supervisory committee or internal auditor

conducted independently of any official or employee; and
0 Maintenance of separate lists of accounts opened and closed for the

information of the directors and supervisory committee by persons
other than those handling the accounting records.
The bylaws and Supervisory Committee Guidefor Federal Credit

Unions contain other examples and information for achieving control
through organization. (Appendix 4A, Conflicting Management
Positions, addresses prohibited positions within the credit union and
the officers or employees.)
Accurate Essentially, the accounting system provides a credit union’s

Financial management with the complete and accurate financial information
Statements needed to conduct sound and effective operations. Management uses
financial statements produced by the system to report to the members,
creditors, insurers, and NCUA. Adherence to generally accepted
accounting principles and standards will assure compliance with the
full and fair disclosure provisions of $702.402 of NCUA Rules and
Regulations.
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EXAMINER’S GUIDE
Other Laws Internal controls are checks and balances built into policies and
and procedures. The FCU Act requires several internal controls, while
Regulations others develop out of daily experience.
Internal controls for credit unions prescribed by law, regulation, or

sound business practices include providing a statement of account to
each member, which shows the record of the member’s transactions,
and obtaining evidence from each borrower regarding receipt of loan
funds.
The credit union’s operating procedures should contain internal

controls such as the following:
0 Dividing duties so that no one person has sole control over any
transaction and its recording;
0 Establishing the flow of work so that one employee, acting

independently, automatically verifies the work of another without
necessarily duplicating any work already performed; and
0 Providing physical and mechanical facilities that support the

maximum level of accuracy and work output.
Internal The formality of any control system will depend largely on a credit
Cont roI union’s size, the sophistication of its operations, the number of
Components employees, and its risk profile. Small credit unions can design less
formal and less structured control systems that can achieve similar
effectiveness as more formal and structured control systems at larger or
more sophisticated credit unions. Effective control systems should
have:
0 A control environment;
0 Risk assessment;
0 Control activities;
0 Accounting, information, and communication systems; and
0 Self-assessment or monitoring.
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INTERNAL CONTROLS
Control The control environment reflects the commitment of the board and
Environment management to internal control. It provides discipline and structure to
the control system. Elements of the control environment include:
The organizational structure of the credit union. (Is the credit

union’s organization centralized or decentralized? Are authorities
and responsibilities clear? Are reporting relationships well
designed?);
Management’s philosophy and operating style. (Are the credit

union’s business strategies formal or informal? Is its philosophy
and operating style conservative or aggressive? Have its risk
strategies been successful?);
Personnel’s integrity, ethics, and competence;
0 The external influences affecting the credit union’s operations and

risk management practices (e.g., independent audits);
The attention and direction provided by the board of directors and

its committees, especially the audit or risk management
committees; and
The effectiveness of human resources’ policies and procedures.
Risk Assessment Risk assessment is the identification, measurement, and analysis of

risks - internal and external, controllable and uncontrollable, at
individual business levels and for the credit union as a whole.
Management must assess all risks in the credit union. Uncontrolled
risk-taking can prevent the credit union from reaching its objectives
and can jeopardize its operations. Effective risk assessment helps
determine the risks, needed controls, and management of those
controls.
Control Activities Control activities are the policies, procedures, and practices
established to help ensure that credit union personnel carry out board
and management directives at every business level throughout the
credit union. These activities help ensure that the board and
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EXAMINER'S GUIDE
management act to control risks that could prevent a credit union from
attaining its objectives. They should include:
Reviews of operating performance and exception reports. For

example, senior management should regularly review reports
showing financial results to date versus budget amounts, and the
loan department manager should review weekly reports on
delinquencies or documentation exceptions;
Approvals and authorization for accessing and performing

transactions and activities, including wire transfers. For example,
an appropriate level of management should approve and authorize
all transactions over a specified limit, and authorization should
require dual signatures;
Segregation of duties to reduce a person's opportunity to commit

and conceal fraud or errors. For example, custody of assets should
not rest with the person who authorizes or records transactions;
Dual control or joint custody over access to assets (e.g., cash,

negotiable collateral, official checks, etc.);
The requirement that officers and employees in sensitive positions

take two consecutive weeks of out-of-office vacation each year, if
practical;
Design and use of documents and records to help ensure recording

of transactions and events. For example, using pre-numbered
documents facilitates monitoring;
Safeguards for access to and use of assets and records. For

example, to safeguard data processing areas, a credit union should
secure facilities and control access to computer programs and data
files; and
Independent checks on completion of jobs and accuracy of

recorded amounts. Examples of independent checks include
account reconciliation, computer-programmed controls,
management review of reports that summarize account balances,
and user review of computer-generated reports.
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INTERNAL CONTROLS
Credit union directors must hold management and staff responsible for
their actions. Credit unions must maintain written procedures or
controls for certain areas, including, but not limited to, lending,
investments, fraud prevention, the Bank Secrecy Act, privacy, and
Truth in Savings. Although credit unions should have written internal
control procedures in all areas, the mere existence of the procedures
will not suffice. Personnel must understand control procedures and
follow them conscientiously.
Control Systems Accounting, information, and communication systems capture and

distribute pertinent and timely information in a form that enables the
board, management, and employees to carry out their responsibilities.
Accounting systems contain the methods and records that identify,

assemble, classify, record, and report a credit union’s transactions.
Information and communication systems assist staff in understanding

(1) how they fit into the credit union’s control system, (2) how their
roles relate to those of others, and (3) how they must maintain their
accountability. Information systems produce reports on operations,
finance, and compliance that enable management and the board to run
the credit union. Management must understand the information
system’s full capabilities (e.g., availability and content of reports.).
Communication systems disburse information throughout the credit
union as well as to members and regulators. (Appendix 4B contains a
list of Information Systems Reports that examiners may find useful
during an examination and when evaluating a credit union’s internal
controls.)
Self-Assessment Self-assessment or monitoring is the credit union’s own oversight of

or Monitoring the control system’s performance; employees within the area evaluate
departmental or operational controls. Part of the normal course of daily
operations and activities should involve ongoing monitoring. Internal
and external audit functions, as part of the monitoring system, may
provide independent assessments of the quality and effectiveness of a
control system’s design and performance.
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EXAMINER’S GUIDE
All credit union personnel should share responsibility for self-

assessment or monitoring. All employees should understand their
responsibility to report breaches of the control system.
Internal Evaluating internal control involves:

Control
EvaIuation Identifying the internal control objectives relevant to the credit
union;
Reviewing pertinent policies, procedures, and documentation;
Discussing controls with appropriate levels of personnel;
Observing the control environment;
Testing transactions as indicated by the level of risk;
Sharing findings, concerns, and recommendations with the board
of directors and senior management; and
Determining that the credit union has promptly corrected noted
deficiencies.
Examiners should base the scope, type, and depth of an internal control
review on the credit union’s size, complexity, scope of activities, and
risk profile. Assessment of the credit union’s audit function plays an
important part in this determination. When management or examiners
note internal control weaknesses, the credit union should take
immediate action to correct the deficiencies.
Strategic The strategies developed by management often determine effectiveness

Risk and efficiency of operations. Factors impacting the control
environment include the integrity and ethical values of management,
the competence of personnel, management philosophy and operating
style, assignment of authority and responsibilities, and the guidance
provided by the board. Examiners should also consider the following
when assessing strategic risk:
Involvement of board and management in the risk evaluation

process. The board should perform due diligence on proposed, new
and existing products and services and should evaluate internal or
external resources used by management to ensure identification
and monitoring of risk areas;
Page 4-8
INTERNAL CONTROLS
0 The competency, knowledge level, and adequacy of resources of

personnel involved in the risk assessment and evaluation
processes;
0 Whether the board and management discuss and appropriately

evaluate risks and consider control issues during the planning
stages for new products and activities;
0 Whether audit personnel or other internal control experts

participate when the credit union develops new products and
activities;
0 Whether the board and management consider and appropriately

address technology issues; and
0 The adequacy of the fidelity bond or other risk insurance coverage

in relation to the requirements in NCUA Rules and Regulations.
Transaction Policies and procedures set by the board and implemented by

Risk management should ensure the accuracy and integrity of data and
information. Examiners should consider the following items when
evaluating this type of risk:
0 Whether current policies and procedures exist to ensure decisions

made by officials, management and staff have appropriate
approvals and authorizations for transactions and activities;
0 Whether accounting controls exist to provide reasonable assurance

that staff carries out transactions according to management’s
authorization, and records transactions to permit accurate and
timely preparation of financial statements;
0 Whether processes exist to ensure that:
- Staff independently verifies the performance and integrity of

each function (e.g., lending, wire transfers, etc.) using an
appropriate sample of transactions;
Page 4-9
INTERNAL CONTROLS
0 Reviewing procedures for imparting significant information

throughout the credit union (from the top down and from the
bottom up in the organizational chain), ensuring that personnel
understand the following:
- Their roles in the control system;

- Their activities in relation to others; and
- Their accountability for the activities they perform;
0 Reviewing information disbursed to external parties for

compliance with fair credit and privacy regulations prior to its
release;
0 Assessing the frequency and thoroughness of verification of

accounting, information, and communication systems by
considering the following:
- Frequency of testing given the level of risk and sophistication

of the systems;
- Sufficiency of ongoing reviews of the systems’ accuracy;
- Competency, knowledge, and independence of the personnel
doing the testing;
0 Determining oversight by senior management and the board over

internal controls, control reviews, and audit findings. The board or
a designated board committee should review management’s actions
to address material control weaknesses and verify the objectivity
and adequacy of corrective actions. Examiner’s should review the
following:
- Minutes of appropriate board and committee meetings, and

- Audits or other control review reports and follow-up reports;
0 Reviewing the frequency and comprehensiveness of reports to the

board or board committee and senior management. Sufficient detail
and timely presentation will allow for resolution and appropriate
action;
0 Assessing the oversight by the board or supervisory committee of

audit and other control functions. The board or supervisory
Page 4-11
EXAMINER'S GUIDE
committee should review the qualifications and independence of

personnel evaluating controls (e.g., external auditors, internal
auditors, or line managers);
0 Evaluating the adequacy and independence of the audit or other

control review function by considering the following:
- Organizational structure and reporting lines;

- Scope and frequency of audits or reviews;
- Results of audit or other control review evaluations and
supporting work papers;
- Audit or control review reports, management responses, and
follow-up reports; and
- Appropriate and prompt attention directed in areas with
identified control weaknesses; and
0 Reviewing management's responses, documentation, and tracking

of findings to enact adequate follow-up. Credit unions should
establish a system of accountability to ensure satisfactory and
effective follow up on control weaknesses.
Workpapers 0 Workpapers
and - Management Review Questionnaires
References - Loan Internal Control Questionnaires
- Loans-Lines of CrediKredit Cards
- Collection Program
- Investment Internal Control Questionnaires
- Cash Control Questionnaire
- Information Systems Review
- RedFlags
- Red Flag Procedures
0 References
- Federal Credit Union Act 5 113
- NCUA Rules and Regulations 5702.402
- Supervisory Committee Guidefor Federal Credit Unions
- Accounting Manual for Federal Credit Unions
- Generally Accepted Accounting Principles
- Federal Credit Union Handbook
Page 4-12
CONFLICTING MANAGEMENT POSITIONS =
APPENDIX 4A
ConfIicting Positions In Federal Credit Unions and Persons Who
Positions are Prohibited From Holding Them
Position Prohibited by Law, Prohibited by Principles of

Regulation, or Bylaw Sound Internal Control
Chief Vice President Member of the supervisory
Executive Secretary committee
Officer Assistant Secretary Supervisory committee assistant
(CEO) Treasurer Credit union employee
Assistant Treasurer
Manager
Assistant Manager
Membership Officer (if the
President countersigns checks)
Assistant President Member of the supervisory
Executive Secretary committee
Officer Assistant Secretary Supervisory committee assistant
Treasurer Credit union employee
Assistant Treasurer
Manager
Assistant Manager
Membership Officer (if the
Vice-president countersigns
checks)
Recording President Member of the supervisory
Officer Vice President committee
(Secretary) Manager Supervisory committee assistant
Assistant Manager Credit union employee
Assistant President
Secretary Vice President
Treasurer
Financial President Member of Credit Committee
Officer Vice President
(Treasurer) Member of the supervisory
committee
Supervisory committee
assistant
Membership Officer
Assistant Secretary
Assistant President Member of the supervisory
Treasurer Vice President committee
Membership Officer Supervisory committee assistant
Director Manager Credit union employee
Assistant Manager
(Only one director may also be
a member of the supervisory
committee)
Page 4A-1
EXAMINER'S GUIDE
Position Prohibited by Law, Prohibited by Principles of

Executive Any officer or employee other Member of the supervisory
Committee than a director (Only directors committee
Member may serve as Executive Member of the credit committee
Committee members) Credit union employee
Membership Officer
Supervisory Member of the credit Loan Officer
Committee committee Credit union Membership Officer
Member employee Assistant Treasurer
Treasurer President
(Only one board member may Vice-president
also serve on this committee.) Secretary
Credit Member of the supervisory Treasurer
Committee committee Manager
Member Supervisory committee
assistant
I
(Only one credit committee
member may also be appointed
a loan officer.)
Loan Officer Membership Officer Member of the supervisory
I
(Only one credit committee committee
member may be appointed a Supervisory committee assistant
loan officer.)
Membership Treasurer Member of the supervisory
Officer Assistant Treasurer committee
Loan Officer Supervisory committee assistant
Manager
Assistant Manager
President or Vice-president if
checks are countersigned
Manager Member of the board of Relative of any official
directors except by bylaw Member of the credit committee
provision
President
Vice-president
Member of the supervisory
committee
Supervisory Committee
Assistant
Membership Officer
Assistant Member of the board of Relative of any official
Manager directors
Member of the supervisory
committee
Assistant
Membership Officer
Page 4A-2
CONFLICTING MANAGEMENT POSITIONS - APPENDIX 4A
Position Prohibited by Law, Prohibited by Principles of I

Supervisory Treasurer Loan Officer
Committee Assistant Treasurer Membership Officer
Assistant Manager Relative of any official or
Assistant Manager employee
Member of the credit Assistant Treasurer
committee President
Credit union employee Vice-president
Secretary
Credit Union Member of the supervisory Relative of any official
Employee committee Member of the board of directors
Assistant
Page 4A-3
4/44w
INFORMATION SYSTEM (IS) REPORTS -
APPENDIX 4B
Examiners may use the following loan, share, and other reports
frequently generated by the credit unions’ information system (IS) to
assist in the review of internal controls whether the credit union
provides a download or generates the reports in-house. Good internal
controls also require regular review of these reports by credit union
management and the internal audit staff.
File Maintenance report - Identifies all changes made through the

computer system that affect members’ accounts. Also called the Non
Financial Transaction report, this report usually differentiates between
old and new data so the user can determine the credit union’s changes.
Changes that occur most often include: addresses, telephone numbers,
loan due dates, payment amounts, interest rates, and maturity dates.
Examiners may review a sample of these changes to determine that
management properly authorized the changes and staff properly
documented them.
Paid Ahead Loans report - Identifies loans with advanced due dates.
When reviewing this report, the examiner should compare the
borrower’s actual payments over time to the note’s required payment
schedule. If discrepancies exist, the examiner should review a sample
of related loan files, being especially cognizant of paid ahead loans
where staff performs frequent file maintenance changes or where the
prior activity date is long past (may be a deficiency balance that the
credit union failed to charge off). Since a payment is due every month
on open-end loans, they should not appear on the paid ahead report.
Most IS reports flag open end loans so they do not appear on this
report; however, the credit union may not have implemented this
feature.
Accrued Interest Greater than Scheduled Payment report - Often

reveals large portions of accrued interest that the credit union has not
collected on specific accounts. In most cases, the majority of borrowers
on this report are also delinquent or the note is a single payment note.
If delinquency is not an issue, the examiner should determine why the
account is on this report.
Page 4B-1
EXAMINER'S GUIDE
No Payments in the Last 90 Days report - Accounts listed are

typically delinquent or single payment notes. This report can help the
examiner pinpoint collection department problems. Examiners should
inquire as to discrepancies between this report and the paid ahead
report, and should review file maintenance changes made to these
accounts.
Interest Rates < 5% or > 18% report - Examiners should review

loan rates that fall into these categories and determine their accuracy.
Interest rates greater than 18% are in error or illegal. Likewise,
examiners should determine reasons for rates less than 5% (loans with
no or special interest rates could be work-out loans).
Supervisory Override report - Documents system overrides by

personnel who have the authority to make the specified changes. Credit
unions should establish parameters that limit employees' access to the
overall IS (proper segregation of duties). Because of staff limitations in
small credit unions, one person may have the authority to make all
changes, making the review of internal controls more critical.
First Payment Date >45 days from Original Loan Date report -
Determines if the credit union has advanced due dates of any closed-
end loans. In cases where the IS calculates delinquency from the first
payment date rather than from the next due date, the IS must change
the first payment when it advances the due date. The credit union
should review the files of the loans appearing on the report to
determine that the credit union appropriately approved an extension.
-
Loan Accounts with a PO Box report Reveals different loan
accounts with the same post office box, which could disclose fictitious
loans.
Non-Amortizing Loans report - Reveals those loans with no

principal reduction over time. Single payment or student loans may
appear on this report. Examiners should review loans on the report and
determine if and why the IS advances due dates.
Cash Transactions over $10,000 report - Identifies cash transactions

that the credit union must report on the Currency Transaction report
Page 4B-2
INFORMATION SYSTEM (IS) REPORTS - APPENDIX 4B
and file with the Treasury Department. The review of this report may
reveal fictitious deposits.
Cash Payment Loans report - Reveals those loan accounts where the
credit union applied cash payments rather than payroll deduction
payments to the remaining principal. Examiners may find this report
useful if they suspect fictitious loan activity.
-
Negative Share and Share Draft report Identifies accounts with
negative balances as of the report date (usually printed as of month
end); however, examiners may ask the credit union to print the report
while they are on-site to determine if the credit union is hiding
overdrafts. Reviewing a sample of related accounts may allow
examiners to ascertain the reasons for and the duration of the negative
accounts.
-
Shares > $100,000 report May identi@the credit union’s share mix,
share concentrations, uninsured shares, and possibly illegal deposits.
Share Accounts with a PO Box report - Reveals if different accounts

have the same post office box. The credit union (or examiners at the
examination) should trace a sample of accounts to membership cards
and review them for validity. If the credit union provides a download
of share accounts, the examiner can apply various sort commands to
the accounts on the report.
NSF’s YTD report - Tracks those members with the most non-
sufficient funds (NSFs) for the year. The credit union (or examiners)
should compare the report to the credit union’s share draft policies to
review for NSF abuse. Most IS can generate this report.
Dormant Share Accounts report - Identifies accounts with no

activity for the past year (or another given time frame.) Examiners
should determine that the credit union is in compliance with the state’s
abandoned property laws.
Insiders’ report - Identifies the accounts of officials and often

includes accounts of key management and family members of officials
and key management.
Page 4B-3
v-n-4&+!L+b
Chapter 5
SUPERVISORY COMMITTEE
TABLE OF CONTENTS
SUPERVISORY COMMITTEE...................................................................................... 5-1

Overview.............................................................................................................. 5. 1
Scope Development and Planning ....................................................................... 5-2
Meeting with the Supervisory Committee ............................................... 5.2
Meeting with the Internal Auditor ........................................................... 5.3
Meeting with the External Auditor and Review of Working Papers .......5-3
Reviewing the Annual Supervisory Committee Audit ........................................ 5.4
Reviewing the Engagement Letter ....................................................................... 5-5
Finding an Audit or Verification Unacceptable ................................................... 5.6
If Compensated Auditor's Audit Appears Lacking .................................. 5.6
Reviewing the Internal Audit Department ........................................................... 5.8
Internal Audit Program Adequacy ........................................................... 5.9
Internal Audit Review .............................................................................. 5. 10
Verifications......................................................................................................... 5. 10
Working Paper Access ......................................................................................... 5. 10
Signing Waiver Document to Gain Working Paper Access .................... 5-11
Supervised Access ................................................................................... 5. 11
Denial of Access ...................................................................................... 5. 12
Addressing Deficiencies with the Supervisory Committee ................................. 5. 12
Mandatory Auditor Rotation ................................................................................ 5. 12
Other Committee Duties ...................................................................................... 5-13
Working Papers and References .......................................................................... 5. 13
APPENDIX 5A .OPINION AUDITS ................................................................. 5A-1
APPENDIX 5B .EXAMINATION OF INTERNAL CONTROL OVER
CALL REPORTING BY CPA............................................................................. 5B-1
APPENDIX 5C .AGREED UPON PROCEDURES ENGAGEMENTS ...........5C-1
APPENDIX 5D .NON OPINION AUDITS ....................................................... 5D-1
Chapter 5
Examination 0 Determine the necessary supervision and examination scope based
0bjectives on the review of the supervisory committee audit, internal audit
reports and risk management reports
0 Determine whether the supervisory committee audit and
verification meets the requirements of $7 15 and $741.202 of the
NCUA Rules and Regulations
0 Determine if the supervisory committee performs other duties to
meet their fiduciary responsibility
0 Determine the advisability of other audits (e.g., e-commerce,
internal control, Statement of Auditing Standard (SAS) No. 70, etc.)
Associated 0 Compliance risk - Includes the risk that the audit and verification
Risks does not comply with the laws and regulations;
0 Reputation risk - Includes the risk that the supervisory committee
did not meet its fiduciary duties, resulting in poor publicity or
administrative action;
0 Strategic risk - Includes the risk that management fails to act on
recommendations included in examinations or internallexternal
audits, or did not allocate the necessary resources to implement
proper internal controls; and
0 Transaction risk - Includes the risk that internal controls do not
sufficiently deter or detect errors, omissions or material
misstatements.
Overview Reviewing the supervisory committee audit is a required and important

aspect of the annual examination. The quality of the audit helps
examiners determine the depth of their review. A quality audit can lead
to examiner confidence in the records and thereby limit the extent of
review. Conversely, a poor audit may necessitate expanding the
examination scope.
The examiner should ensure that persons performing the audit and
verification functions performed them in accordance with $715 of
Page 5-1
EXAMINER'S GUIDE
NCUA 's Rules and Regulations. The examiner's review and evaluation
of these functions serve as key elements in determining the
examination's scope. Examiners will complete the required
questionnaire, SC- Pre-Examination Supervisory Committee Audit
And Verification Review.
Additionally, examiners may also complete the following optional

questionnaires depending on the type of audit performed:
SC-Financial Statement Audit by CPA (described in Appendix A);

0 SC-Balance Sheet Only Audit by CPA (described in Appendix A);
0 SC-Examination of Internal Control over Call Reporting by CPA
(described in Appendix B); and,
SC- Non-Opinion (described in Appendix C or D).
Scope The following documents can provide guidance for the examiner
Development during the scope development and planning phase:
and Planning
0 Any report of reportable conditions or material weaknesses
(sometimes referred to as a management letter);
The annual audit report;
0 Engagement Letter;
0 Internal audit reports, if any;
0 Risk management or any other applicable audits, if any;
0 Support for the verification of accounts; and
0 Minutes of the supervisory committee meetings;
Meeting with the The examiner may arrange a meeting with the chairman of the
Supervisory supervisory committee to:
Committee
0 Explain the examiner's mission in reviewing the audit and
verification functions;
0 Discuss the supervisory committee's role and responsibilities, if
necessary ($715.3);
0 Answer any questions the supervisory committee may have; and
0 Determine the extent of the committee's knowledge of the credit
union's operations, management, and the status of the credit union's
financial condition.
Page 5-2
Meeting with the The examiner may arrange a meeting with the internal auditor to:
Internal Auditor
0 Evaluate the independence and experience of personnel conducting
internal control reviews, adequacy of staff size, appropriateness of
audit schedule, and sufficiency of scope;
0 Assess the reliability and effectiveness of any internal control
review;
0 Review audit reports, letters reporting material weaknesses or
reportable conditions, and management’s written response to
auditors’ findings; and
0 Review internal audit working papers.
Meeting with the The type of audit and the examiner’s familiarity with the external
ExternalAuditor auditor will determine the extent of the meeting and review of the
and Review Of audit working papers. If examiners choose to contact the external
Working Papers auditor, they may find it beneficial to obtain the auditor’s risk
assessment, their conclusions, and resulting modifications to the audit
program, including the following:
Auditor memorandums relating to audit planning, preliminary

analytical procedures, materiality thresholds, discussions with
management, etc; and
0 Working papers related to general risks (client’s business and

industry; significant changes; materiality; general summary of
internal controls; and general assessment of risk) and the auditor’s
assessment detailing conclusions reached.
To clarify the auditor’s risk assessment as it relates to the examination

scope, the examiner should ask about the following:
0 Significant accounts (higher risk is generally localized in a few

account balances);
0 Risk level assessed (low, moderate, high) for inherent, control,

detection, and assertions risk for each significant account.
Inherent risk plus Control risk = Risk of Material
Misstatement (RMM);
Page 5-3
EXAMINER’S GUIDE
0 Risk factors in place to mitigate risk (e.g., monitoring by third

parties, inquiry or observation of controls, prior audit experience,
and procedures performed in understanding and testing controls
provide evidential matter);
0 Conclusions and findings of control testing. No assurance =

Maximum control risk; and
0 The auditor’s assessment of combined risk (RMM) and resulting

determination of audit program steps.
The examiners’ understanding of these aspects of the auditor’s work

may help them plan and determine the examination scope. If examiners
decide to review the supervisory committee and its functions, but have
not obtained the information discussed above in the planning phase,
they should obtain these items early in the fieldwork phase to
minimize duplication of effort, when possible. If the examiners cannot
rely on the work of the external auditor, they may need the duplication
of efforts to properly assess risk areas.
Reviewing NCUA Rules and Regulations $715.4-$715.8 set forth the minimum
the Annual requirements for a supervisory committee audit and verification
Supervisory consistent with the FCUAct $1 15. Supervisory committees often
Committee engage external auditors to assist them in meeting this requirement.
Audit
The approach the examiner should take in reviewing the audit depends
on the type of audit for which the supervisory committee contracted:
Financial statement opinion audit (Appendix A);

Balance sheet only opinion audit (Appendix A);
An examination of internal controls over call reporting (Appendix
B); or
Other supervisory committee audits such as:
- CPA Agreed-Upon Procedures Audits (Appendix C); and
- Non-opinion audits (Appendix D).
Certain circumstances may prompt the examiner to consider requiring

an independent audit performed by a CPA. Refer to $715.11, Sanctions
for failure to comply with this part, and $715.12, Statutory audit
Page 5-4
remedies for Federal Credit Unions, of the NCUA Rules and

Regulations.
Reviewing NCUA Rules and Regulations $7 15.9 (b), Engagement letter, requires
the that the supervisory committee obtain an engagement letter when they
Engagement hire a compensated auditor. Also, $715.9(c), Contents of the letter,
Letter $715.9(d), Complete scope, and $ $715.9(e), Exclusions from scope,
discuss the minimum requirements for such an engagement letter.
CPAs generally submit engagement letters to the supervisory

committee before beginning their work. The examiner should review
the engagement letter in light of $5715.9 (b) through (e) to determine if
the supervisory committee properly contracted for the audit. Examiners
may find these letters a source of valuable information. These letters
include, among other things, the audit scope, the audit period, and the
expected reports. In many cases, the auditor will summarize highlights
of these matters in the body of the letter and provide greater detail in
schedules or appendices to the letter. The letter may specify procedures
for various audit areas. In addition, it may specify any limitations on
the auditor’s scope, including omission of auditing procedures (e.g.,
evaluation of the allowance for loan losses or confirmation of loans or
deposits, if required.)
Sometimes, a supervisory committee can predetermine an

unacceptable audit simply by failing to include necessary items (scope,
timing, delivery, etc.) Examiners should review the Engagement Letter
to ensure the supervisory committee contracted for an acceptable audit.
$715.9 of the NCUA Rules and Regulations encourages improved
contracting practices with the goal of improving compliance with
regulatory requirements for audits.
Engagement letter provisions particularly helpful to the examination

process, if enforced, include:
0 Timely delivery of the audit report within 120 days of completion

of the period under audit ($715.9(~)(6));
0 Except for opinion audits, the appendix to the letter setting forth
the agreed upon procedures ($715.9(~)(3));
.e Page 5-5
EXAMINER'S GUIDE
0 Certified scope, or alternatively a list of exclusions from scope and

qualifying reminder that the supervisory committee remains
responsible for excluded scope ($7 15.9(d)(e)); and
A clause to the effect that the independent accountant agrees to
permit the regulator to review and to photocopy applicable original
working papers, as the regulator may request ($715.9(~)(7)).
Finding an Examiners may consider an audit or verification unacceptable and may

Audit or develop plans of action when they determine:
Verification
Unacceptable The audit scope did not include material areas of the credit union
operations;
0 Working papers do not support material parts of the audit; or
0 Lack of independent control over the verification process.
When examiners take exception to the annual supervisory committee

audit, they should convey the following information to the credit union
and document it in the examination working papers:
0 Specific audit sections in question;

0 Records or accounts with significant errors or record keeping
deficiencies; and
0 Time anticipated for resolving the problems.
Examiners should consult with their supervisory examiners, and in

state-chartered credit unions the state supervisory authority, before
enforcing NCUA Rules and Regulations $715.1 1, Sanctions for Failure
to Comply With This Part and 5715.12, Statutory Audit Remedies for
Federal Credit Unions.
If Compensated When examiners have concerns with the acceptability of the CPA's
Auditor's Audit work, they have several options available. At a minimum, they should
Appears sit down with the CPA and discuss their concerns. The meeting will
serve as a fact-gathering opportunity that assists the examiner in
determining whether the auditors used additional audit steps and if so,
how they used the additional steps. Examiners must maintain their
objectivity and independence, and should reserve adverse, constructive
comments for the final meeting with the supervisory committee. If the
Page 5-6
supervisory committee agrees with the examiner's conclusions, they

should together determine timeframes for making the corrections.
If, after reviewing the audit working papers and discussing concerns
with the independent accountant, examiners have not satisfied
themselves that the independent accountant met the minimum
requirements of the audit, they should consult with their supervisory
examiners. Examiners should clearly describe the circumstances,
procedures followed, findings, and conclusions in their working
papers. If examiners cannot determine adequate completion of certain
audit steps or if they have concerns with independence or
thoroughness, they should discuss all major audit findings with the
supervisory committee and document the discussion in their working
papers. Additionally, an examiner may:
0 Recommend that the supervisory committee perform the additional

tests in the coming year, before the next examination, to provide
NCUA with needed assurances; or
0 Recommend that the board and supervisory committee include
additional special procedures in engagement letters of future
audits.
In extreme, rare, and well-documented instances, supervisory

examiners should consult with the regional director or associate
regional director regarding cases that may require forwarding referrals
through the Office of Examination and Insurance to either the state
licensing authority, the AICPA Ethics Division, or to take other action
as the Office of General Counsel may advise.
In such cases, examiners should not rate the audit itself unacceptable
even though they cannot determine evidence of the satisfactory
completion of various test checks or audit procedures. NCUA's policy
is that independent, licensed, certified public accountants have
established and documented auditing standards which govern their
work, whether "opinion" audits (GAAS) or "agreed-upon procedures''
engagements (refer to SSAE No. 10). Before examiners find audits
"unacceptable" in meeting $7 15, they should request that Central
Office program and legal staff perform a review in relation to the
professional accounting and auditing standards, and the likelihood of
prevailing (costhenefit) should the agency decide to proceed legally.
Page 5-7
EXAMINER'S GUIDE
NCUA recognizes that independent accountants can err. Therefore,

agency policy encourages examiners to review and to question, when
appropriate, an independent accountant's work. However, examiners
should stop short of labeling the audit ''unacceptable", unless NCUA
can solidly assert that the CPA fell short of this standard and support
this assertion in a due process proceeding.
Reviewing Internal auditors can serve several valuable functions. They appraise
the Internal the soundness and adequacy of accounting, operating and
Audit administrative controls.
Department
The success of the internal audit function depends in large part on the
independence maintained by internal audit personnel. Internal auditors
should report directly to the supervisory or audit committee, rather
than to management. This enables the function to be "free from
influence" of management and, to some degree, the board of directors.
The major factors that the examiner must consider while reviewing and
evaluating the internal audit function are (1) the independence and
thoroughness of the internal auditors, and (2) the adequacy and
effectiveness of the audit program.
The qualifications and responsibilities of internal auditors vary with

the credit union's size and complexity and the emphasis that the board
places on the audit function. In some credit unions, auditors have no
other responsibilities beyond the internal audit function; in others, they
are regular employees with part-time audit duties.
Examiners should satisfy themselves that audit staff supervisors

possess an adequate knowledge of audit objectives and an
understanding of the audit procedures performed by the staff.
The final measure of the auditor's thoroughness is the quality of the

work performed and the ability to communicate the results of that
work. Accordingly, the examiner's conclusions should reflect the
adequacy of the audit program and the audit reports.
Page 5-8
Internal Audit The examiner should consider the following:

Program
Adequacy 0 Scope and frequency of the audit work;
0 Documentation of the work performed;
0 Content of the audit programs; and
0 Conclusions reached and reports issued.
A documented record of the work performed (best created through

audit working papers) must exist. These working papers should
contain, among other things, audit work programs and analyses that
clearly indicate the procedures performed, the extent of testing, and the
basis for the conclusions reached.
Audit work programs deserve separate attention. The work programs,

normally found in large complex credit unions with internal audit
departments, serve as the primary evidence of the audit procedures
planned and performed. As such, they should be written and should
cover key areas of a credit union's operations. Each program should
provide a clear, concise description of the audit work required, and
present individual audit procedures logically. The detailed procedures
included in the program will vary depending on, among other factors,
the size and complexity of the credit union's operations. Most audit
programs should include:
0 Surprise audits, where appropriate;

0 Maintenance of control over records selected for audit;
0 Review and evaluation of the credit union's policies and procedures
and the system of internal control;
0 Proof of detail to related control records; and
0 Verification of selected transactions or balances.
Completion of the specific procedures included in all work programs

should enable the internal auditor to reach conclusions that will satisfy
the related audit objectives. The work performed should support
conclusions drawn and audit reports prepared from the work program
results. When appropriate, the reports should include the internal
auditor's recommendations for required remedial actions.
Page 5-9
EXAMINER’S GUIDE
Prompt and effective management response to the auditor’s

recommendations is the final measure of the audit program’s
effectiveness.
Internal Audit The examiner’sreview and evaluation of the internal audit function are
Review key elements in determining the scope of the examination. Based on
careful evaluation, examiners should conclude whether they find the
work performed by the internal auditors acceptable, partially
acceptable, or not acceptable.
The concept of partial reliance or acceptability applies only to the

review and evaluation of the internal audit function. The examiner may
detect weaknesses in the internal audit function or procedures that are
not of such magnitude to make the internal audit function
unacceptable. In such situations, the examiner should draw a partially
acceptable conclusion.
Verif iCatiOnS NCUA requires federal credit union supervisory committees to verify
the members’ accounts with the credit union’s records at least once
every two years. NCUA Rules and Regulations 5715.8, Requirements
for verification of accounts and passbooks, provides that the
supervisory committee (or their representative) can base the
verification on a 100 percent sample, a random statistical sample, or,
for CPAs only, a non-statistical sampling option. Examiners should
refer to Chapter 24 of the Supervisory Committee Guide, “What Must
a Verification Involve?”
Working In reviewing the audit, the examiner should determine if the auditor
Paper Access properly documented completed audit procedures in working papers in
support of the audit or verification report. The NCUA Rules and
Regulations 57 15.10, Audit report and working paper maintenance and
access, requires the committee to maintain adequate working papers to
support its audits.
The auditor’s working papers include all the evidence gathered to show
work done, the methods and procedures followed, and the conclusions
reached. There are no standard working papers. The committee or
Page 5-10
auditor prepares working papers that best serve their intended purpose.
The working papers should:
0 Coordinate and organize all phases of the audit;

0 Facilitate preparation of the final audit report; and
Substantiate in detail the opinions and findings in the report.
When the supervisory committee performs the verification or audit, the

examiner generally has little or no difficulty accessing the original
working papers. These papers form the basis for judging the adequacy
of a supervisory committee audit.
Examiners may have more difficulty obtaining the working papers

when the supervisory committee directs a CPA to complete some or all
of the work. Independent accountants generally consider the working
papers confidential and the property of the accounting firm. The CPA
may ask that the examiner:
0 Sign a document before obtaining access to working papers; and/or

0 Review the working papers in the CPA’s office.
In the latter case, the auditor may also require the presence of an
employee during the examiner’s review. With the exception of signing
a waiver document, the examiner should cooperate as fully as possible
with these practices.
Signing Waiver It is NCUA’s policy that examiners not sign waiver letters. Most
Document to letters go beyond simply acknowledging receipt of the working papers.
Gain Working The letters often contain qualifying language and restrictions on the
Paper Access
regulator’s use of information obtained in the working papers.
Supervised Reviewing working papers may require significant time and travel
Access when the auditing firm is not local. In such instances, the examiner-in-
charge may arrange through the supervisory examiner for another
examiner to review the working papers. While auditing firms generally
permit examiners supervised access, some will not permit examiners to
photocopy original working papers. Regional or national accounting
firms often have this policy. An examiner should not take exception to
Page 5-11
EXAMINER'S GUIDE
the denial of photocopying privileges unless it clearly and directly

affects the examiner's ability to discern and document the audit's
acceptability.
Denial of Access In rare instances, an independent auditor may refuse the examiner
access to working papers. The examiner should then contact the
supervisory committee chairman for help in getting access to the
papers. NCUA Rules and Regulations $715.1O(b), Working papers,
requires allowing the examiner access to original audit working papers.
If the auditor still refuses, examiners should notify the supervisory
committee that they could rate the auditor's work unacceptable and
possibly require the supervisory committee to re-do it. With some of
the larger firms, the Office of Examination and Insurance (EM) can
assist in obtaining examiner access by contacting and interceding at the
national level.
Examiners should reserve comments about audit working papers until

they finish the review and develop an overall picture of the work's
adequacy. After completing the review, the examiner discusses the
findings with the auditor and the supervisory committee.
Add ressing Examiners should reach specific agreements with the supervisory
Deficiencies committee to correct deficiencies during the next audit or verification
with the or within a reasonable time. Examiners should request that the board
Supervisory president invite the chairman or whole committee to the joint
Committee conference or exit interview.
Mandatory If a credit union has used a particular external auditor for a series of
Auditor years, and the independence, competence, and level of audit work is
Rotation otherwise adequate, examiners should not recommend that the credit
union routinely rotate external auditors. Examiners should not suggest
auditor rotation for rotation-sake. If examiners have concerns about the
quality of the audit, they should document these specific concerns and
raise them with the supervisory committee. The questioning of a
particular auditor's quality of work and citing of $715.1 1 and 9715.12
in applicable circumstances will most likely bring the supervisory
committee to its own conclusion to hire another auditor.
Page 5-12
Other The supervisory committee has responsibilities beyond the audit and
Committee verification finctions. These additional duties (Chapter 4 of the
Duties Supervisory Committee Guide) include (1) resolution of member
complaints; (2) strengthening internal controls; (3) authority to call
special membership meetings and remove officers, directors, or credit
committee members; and (4)reviewing management’s corrective
action.
Working 0 Working papers

Papers and - Scope Workbook
References - Supervisory Committee Questionnaires
(Required) SC - Supervisory Committee Audit and
Verification Review; and
(Optional) depending on the type of audit performed:
SC-Financial Statement Audit by CPA;
SC-Balance Sheet Only Audit by CPA;
SC-Examination of Internal Controls over Call
Reporting by CPA; and,
SC- Non-Opinion
0 References
- Federal Credit Union Act
11 1 - Compensation
1 15 - Supervisory Committee
- Federal Credit Union Bylaws
Article IV ( 12/87 and 10/91)- Meeting of Members
Article V (10/99) - Meetings of Members
Article X (12/87 and 10/91)- Supervisory Committee
Article IX (10/99) - Supervisory Committee
- NCUA Rules and Regulations
715 - Supervisory Committee Audit
74 1.202 - Requirements for Insurance
- Supervisory Committee Guide
- AICPA Audit and Accounting Guide (relevant to Credit
Unions)
Page 5-13
5v4 &dJ
OPINION AUDITS = APPENDIX 5A
Reviewing An “opinion audit” expresses an opinion on the fair presentation of the
Financial financial statements in all material respects in accordance with
Statement or generally accepted accounting principles (GAAP). These audits
BaI ance include the following:
Sheet Only
Opinion 0 A financial statement audit - the auditor will audit the balance
Audits sheet, income statement, statement of equity and other
comprehensive income, and statement of cash flows, and will
present an opinion on all the statements, taken as a whole; or
0 A balance sheet only audit - the auditor will audit the balance sheet
and render an opinion. That means the auditor will not audit the
income statement accounts, statement of equity and other
comprehensive income, and statement of cash flow information.
The objective of an independent, licensed CPA conducting an audit

differs from the objectives of an internal audit or an NCUA
examination. In unusual situations, the examiner may conduct an in-
depth review of the thoroughness and independence of the CPA or the
adequacy of the CPA’s audit.
The American Institute of Certified Public Accountants (AICPA)

establishes standards for thoroughness and independence of CPAs, the
auditing standards CPAs must follow in connection with their audits of
financial statements, and standards governing CPAs’ reports. All
CPAs are not members of the AICPA; however, all must follow
professional standards adopted, whether by their respective state
societies or the state agency issuing their licenses.
Peer Review Accounting firms receive a peer review (a quality control-type review)
performed by another (external) certified public accounting firm on a
regular basis (every two to three years). The examiner should request
and review a copy of the most recent peer review report. They should
note any areas that may trigger expansion of procedures or reduced
reliance on the audit and verification.
Page 5A-1
OPINION AUDITS - APPENDIX 5A
review of the CPA's working papers. If the procedures satisfy the Part
715 requirements, the examiner can rely on the work performed.
If an examiner remains concerned that the auditor has not complied

with independence standards, the examiner should document these
concerns and follow the guidance detailed in the Supervisory
Committee chapter. Examiners should not state, either orally or in
examination reports or working papers, that they question the CPA's
independence.
Review of Fieldwork standards require the following:

Compliance
with Fie'dwork 0 Adequately planned work;
Standards 0 Properly supervised assistants, if any;
0 Proper study and evaluation of existing internal controls as a basis
for reliance thereon for determining the audit scope and
procedures, including the extent of testing; and
0 Sufficient evidence to afford a reasonable basis for an opinion
regarding the financial statements under audit.
The examiner may occasionally have sufficient reason to question a

CPA's thoroughness. If the examiner questions thoroughness, the
examiner should not rely on any work performed by the CPA without
reviewing the procedures followed in the audit. If the procedures
satisfy the Part 715 requirements, the examiner should rely on the
work performed.
Review of The examiner should review the last report issued by the CPA. If an
Audit audit is currently in progress, the examiner may review the engagement
Procedures letter, the auditors' risk assessment, and their conclusions and resulting
modifications to the audit program.
The examiner should obtain and review any adjusting journal entries
suggested by the CPA to determine if such entries are normal recurring
accruals or if the entries indicate inadequate accounting records.
Page 5A-3
EXAMINER'S GUIDE
Standards The reporting standards deserve particular attention because examiners

Governing must understand CPAs and their functions. Reporting standards require
Reporting that CPAs:
0 Conduct their audits in accordance with generally accepted

auditing standards (GAAS);
0 State whether they presented the financial statements in conformity
with generally accepted accounting principles (GAAP); and
0 State whether such principles have been consistently applied in the
current period in relation to the preceding period.
In addition, the CPA must provide reasonably adequate informative

disclosures in the financial statements or otherwise in the report. The
report must contain an expression of opinion regarding the financial
statements taken as a whole, or an assertion that the CPA cannot
express an opinion. The CPA must state in the report any reasons for
the inability to express an overall opinion on the financial statements.
When no material exception exists, the CPA will issue an unqualified

(clean) opinion. When a material exception exists, but not so material
as to negate an opinion on the financial statements taken as a whole, a
qualified opinion is appropriate. Judgment in the circumstances
determines what is sufficiently material. If the matter relates to the
scope of the procedures or the fairness of presentation of the financial
statements, the phrase, "except for'' normally appears. Only in
situations where an uncertainty exists should the auditor use the phrase
"subject to". The following circumstances may require departure from
the auditor's standard report:
0 The credit union has restricted the scope of the audit, or conditions
exist that do not permit the application of auditing procedures
considered necessary in the circumstances;
0 Inadequate disclosure or lack of conformity with GAAP affect the
financial statements in that they do not fairly present financial
conditions, results of operations, or changes in financial position;
0 Consistent application of accounting principles has not occurred;
or
0 Unusual uncertainties exist as to the outcome of future events, and
the auditor cannot reasonably estimate their effect on the financial
statements.
Page 5A-4
OPINION AUDITS - APPENDIX 5A
CPAs issue an adverse opinion when the matter to which they have
taken exception is so pervasive that the financial statements do not
present fairly the financial position, results of operations, or change in
financial position, or do not conform to GAAP.
CPAs issue a disclaimer of opinion when either the credit union or

circumstances restricted the scope of their examination in important
respects, or when uncertainties affect the financial statements.
In the case of a qualified, adverse or disclaimer of opinion, the auditor

should set forth all material reasons for issuing the particular report
form. As to limitations of scope, the report would specify the omission
of any generally accepted auditing procedures and the reasons for the
omission. If the credit union requested the omission, the report should
so specify.
If examiners remain concerned that the CPA did not comply with
general standards, the standards of fieldwork or the reporting
standards, they should document the concerns and refer to the section
of the Supervisory Committee chapter entitled, “If Compensated
Auditor’s Audit Appears Lacking” for guidance on how to proceed.
Examiners should not state, either orally or in examination reports or
working papers, that they question the CPA’s competence.
References 0 Supervisory Committee Guide

0 AICPA Audit and Accounting Guide, Audits of Credit Unions
Page 5A-5
5-74 “6 m
EXAMINATION OF INTERNAL CONTROL OVER
CALL REPORTING BY A CPA APPENDIX 5B -
Engagement Performing an examination of internal control over call reporting
Performance requires that the auditor:
Plan the engagement;

0 Obtain an understanding of internal control;
0 Evaluate the design effectiveness of the controls;
Test and evaluate the operating effectiveness of the controls; and
Form an opinion on the effectiveness of the credit union’s internal
control, or management’s assertion, thereon, based on the control
criteria. (AT 400.16)
Reviewing an The examination of internal control over call reporting differs from an
Examination audit of the financial statements in many ways, including the
of Internal following:
Control Over
Call 0 In a financial statement audit, the auditors’ consideration of
Reporting internal control enables the auditor to plan the audit and determine
the nature, timing, and extent of testing they will need to perform.
Such work forms the basis for the expression of an opinion on the
fair presentation of the financial statements, taken as a whole, in all
material respects in accordance with GAAP.
0 In an examination of internal control over call reporting, the

auditor examines management’s assertion about the effectiveness
of the credit union’s internal control, to express an opinion about
whether the credit union maintained, in all material respects,
effective internal control as of a point in time based on chosen
control criteria.
Accordingly, an auditor’s consideration of internal control in a

financial statement audit is much more limited than that of an auditor
engaged to examine management’s assertion about the effectiveness of
the credit union’s internal control over call reporting.
Page 5B-1
EXAMINER’S GUIDE
In examining management’s assertions with regard to internal control

over call reporting, the auditor can express an opinion on either of the
following:
0 The effectiveness of the credit union’s internal control, in all

material respects, based on the control criteria; or
0 Whether management has fairly stated its assertion about the

effectiveness of internal control, in all material respects, based on
the control criteria.
The opinion relates to the credit union’s internal control taken as a

whole, and not to the effectiveness of each individual component.
A credit union’s internal control over call reporting includes those

policies and procedures that pertain to the credit union’s ability to
record, process, summarize, and report financial data consistent with
the assertions embodied in the call report. Management may present its
assertions about the effectiveness of the credit union’s internal control
in either a separate report that will accompany the auditor’s report or a
representation letter to the auditor.
An auditor engaged to examine management’s assertion about the

effectiveness of a credit union’s internal control should comply with
the general, fieldwork and reporting standards relative to “opinion
audits.” (See the Supervisory Committee chapter for additional
information.) This appendix also discusses some additional
requirements the auditor should perform.
Management’s A sample management assertion might read as follows:

Assertion and
Represen - . . . that ABC Federal Credit Union maintained effective internal
tations control over call reporting as of [date];
or
. . . that ABC Federal Credit Union’s internal control over call
reporting sufficiently meets the stated objects as of [date].
For many credit unions, the auditor may help management draft the
written assertion, which will become the subject of the engagement.
Page 5B-2
EXAMINATION OF INTERNAL CONTROL - APPENDIX 5B
Management will also provide the auditor written representations,

which may include the following:
Acknowledging management’s responsibility for establishing and

maintaining internal control;
Stating that management has performed an evaluation of the

effectiveness of the credit union’s internal control and specifying
the control criteria used;
Stating that management has disclosed all significant deficiencies

in the internal controls that could adversely affect the credit
union’s ability to record, process, summarize, and report financial
data in the call reports;
Describing any fraud that involves management or other employees

who have a significant role in internal control; or
Stating whether any subsequent internal control changes occurred,

including any corrective actions taken by management with regard
to significant deficiencies and material weaknesses.
Management’s refusal to furnish all required representations could

cause the auditor to qualify or disclaim an opinion in the report.
Contro I By selecting the definition and description of internal control for the
Criteria purpose of assessing its effectiveness, management determines the
components of the credit union’s internal control (AT400.12). The
internal control framework most often cited, and the one most credit
unions will select, based on the advice of their auditor, will most likely
be Internal Control-Integrated Framework, published by the
Committee of Sponsoring Orgnaizations (COSO) of the Treadway
Commission. This definition and description of internal control
includes the following five components:
0 Control environment;
0 Risk assessment;
Control activities;
Page 5B-3
EXAMINER’S GUIDE
0 Information and communication; and

0 Monitoring.
This appendix does not provide an in-depth discussion of these control

criteria, or of other control criteria the credit union may use. The
management assertion under examination should specify and describe
the control criteria management has selected for examination of the
credit union’s internal controls.
Engagement Some of the types of auditor functions and documentation an examiner

Performance should see when reviewing work-steps and working papers for an
Internal Control Over Call Reporting engagement include the
following:
0 Planning the engagement:
- Review overall strategy for the scope and performance of the

engagement;
- Understand financial reporting practices, economic conditions,
laws and regulations, technological changes, organization,
operating characteristics, capital structure, etc.;
- Review preliminary judgments about materiality levels,
inherent risk, and other factors relating to possible material
weaknesses; and
- Review preliminary judgments about the effectiveness of
internal control (internal audit function).
0 Obtain an understanding of internal control:
- Inquire of appropriate management, supervisory, and staff

personnel;
- Inspect credit union documents; and
- Observe credit union activities and operations.
0 Evaluate the design effectiveness of the controls:
- understand controls within each component of internal control;

and
Page 5B-4
EXAMINATION OF INTERNAL CONTROL - APPENDIX 5B
- Focus on the significance of controls in achieving the

objectives of the control criteria rather than on specific controls
in isolation.
0 Test and evaluate the operating effectiveness of the controls:
- Obtain sufficient evidence to support the opinion and

corroborate the results of the tests; and
- Perform tests of controls to learn the nature of the control,
significance of the control in achieving the control criteria,
operating effectiveness of the control, risk of noncompliance
with the control, etc.
0 Form An Opinion:
- Communicate reportable conditions and material weaknesses.

- Report should include the following regarding the examination
of Internal Control Over Call Reporting by a CPA (AT 400.45):
1. Title which includes “independent”;

..
11. Identification or statement of management’s assertion
about the effectiveness of the credit union’s internal
control over call reporting;
...
111. Statement that the assertion is the responsibility of
management;
iv. Statement that the auditor’s responsibility is to state an
opinion with regard to management’s assertion;
V. Statement that the examination was conducted in
accordance with attestation standards of the AICPA;
vi . Statement that the examination provides a reasonable
basis for the opinion;
vii. The opinion; and
...
v111. Auditor’s signature and date.
Example of Following is a sample, unqualified opinion as set forth in attestation

Auditor’s standards (AT 400.46) that an examiner might see as the product of
Written this type of engagement:
Opinion
Page 5B-5
EXAMINER'S GUIDE
We have examined management's assertion included in the accompanying

[title of management report], that ABC Federal Credit Union maintained
effective internal control over call reporting as of December 3 1,200X based
on [identify stated or established criteria]. Management is responsible for
maintaining effective internal control over call reporting. Our responsibility
is to express an opinion on the effectiveness of internal control based on our
examination.
Our examination was conducted in accordance with attestation standards

established by the American Institute of Certified Public Accountants and,
accordingly, included obtaining an understanding of internal control over
call reporting, testing, and evaluating the design and operating effectiveness
of internal control, and performing such other procedures as we considered
necessary in the circumstances. We believe that our examination provides a
reasonable basis for our opinion.
Because of inherent limitations in any internal control, misstatements due to

error or fraud may occur and not be detected. Also, projections of any
evaluation of internal control over call reporting to fiture periods are
subject to the risk that internal control may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, ABC Federal Credit Union maintained, in all material

respects, effective internal control over call reporting as of December 3 1,
200X, based on [identify stated or established criteria].
References 0 AICPA Audit and Accounting Guide (relevant to Credit Unions)
Page 5B-6
AGREED UPON PROCEDURES ENGAGEMENTS -
APPENDIX 5C
Agreed Upon Supervisory committees may hire CPAs to perform a review that, in
Procedures conjunction with procedures performed by the supervisory committee,
Audit meets the minimum requirements of a supervisory committee guide
Performed By audit under Part 715 of the NCUA Rules and Regulations. Statement
a CPA on Standards for Attestation Engagements (SSAE) No. 10 guides the
independent accountant’s performance for this type of engagement.
An agreed upon procedures (AUP) engagement is one in which the

credit union supervisory committee engages an independent accountant
to issue a report of findings based on specific procedures performed on
specified subject matter (elements, accounts, or items of the financial
statements.) The supervisory committee and the independent
accountant agree upon the procedures that the supervisory committee
believes the independent accountant should perform (Supervisory
Committee Guide, Appendix A sets forth minimum procedures).
Agreement on The supervisory committee has responsibility for the sufficiency

Sufficiency of (nature, timing, and extent) of the procedures. The examiner reviews
Procedures the supervisory committee function and the annual audit report for
compliance with the Federal Credit Union Act and Part 715 of the
NCUA Rules and Regulations.
Some independent accountants may seek NCUA’s written assurance

on the sufficiency of the procedures and ask NCUA to take
responsibility for sufficiency of the procedures along with the
supervisory committee. Examiners should not provide such assurances
nor agree to NCUA’s being identified as a specified user.
Standards Examiners should understand that the general (training and

Governing proficiency, adequate knowledge of subject matter, suitability and
Agreed Upon availability of criteria, independence, due professional care), fieldwork
Procedures by
(planning and supervision, obtaining sufficient evidence,
a CPA
representation letter), and reporting standards for attestation
Page 5C-1
EXAMINER'S GUIDE
engagements govern the performance and reporting by independent

accountants for these types of engagements (AT 101 and 201.)
Examiner's The examiner should focus on the following:

Review of
Agreed Upon 0 Whether the (combined) scope of work adequately meet NCUA
Procedures by
Rules and Regulations 57 15.7, Supervisory Committee audit
a CPA
alternatives to a financial statement audit, and related minimum
requirements set forth in Appendix A of the Supervisory
Committee Guide. (Scope includes aggregate work performed by
the supervisory committee, audit work performed by others, and
agreed upon procedures performed by a CPA.); and
0 Whether individuals performing the work used procedures

adequate to fulfill the scope requirements (i.e., can users place full
reliance on the procedures performed.)
Scope Review In reviewing and assessing the adequacy of the audit's scope, the
examiner should use good judgment and reasonableness in what they
deem acceptable. The Supervisory Committee Guide, Appendix A, sets
forth the minimum audit scope. NCUA has provided the following in
its Guide:
By publishing this Appendix, NCUA is not representingthat a

supervisory committee which performs or has performed these
minimum procedures, and these procedures only, will have fully meet
the requirements of Part 7 15.
The supervisory committee determines the scope of the work based on

the risk, exposure, and other circumstances of the individual credit
union. The supervisory committee must ensure that the audit meets the
minimum requirements of NCUA Rules and Regulations Part 7 15.
They cannot delegate that responsibility to a CPA. The engagement
letter may omit certain key scope requirements (e.g., assessment of the
reasonableness of the allowance for loan losses in the valuation of
loans.) Consequently, the CPA may meet the terms of the engagement
letter yet the audit scope may lack key scope requirements. The
examiner should direct findings and exceptions about scope to the
supervisory committee, not the CPA.
Page 5C-2
AGREED UPON PROCEDURES ENGAGEMENTS - APPENDIX 5C
If, on the other hand, the CPA did not meet the engagement letter
obligation or the examiner has independence or thoroughness
concerns, the examiner should follow the procedures outlined in the
Supervisory Committee chapter for taking action regarding the
independent accountant.
Review of Attestation standards limit the procedures independent accountants can

Procedures perform. They cannot perform procedures open to varying
Performed to interpretations. Independent accountants should not use terms of
Meet Scope
uncertain meaning (e.g., general review, limited review, check, or test)
to describe the procedures. Examiners should understand this aspect of
professional standards when evaluating work steps performed by an
independent accountant to meet NCUA Rules and Regulations
$715.7(c) requirements.
Examples of appropriate procedures include (AT 201.17):
0 Execution of a sampling application after agreeing on relevant

parameters;
0 Inspection of specified documents detailing attributes thereof;
0 Confirmation of specific information with third parties; and
0 Comparison of documents, schedules, or analyses with certain
specified attributes.
Examples of inappropriate procedures include (AT 201.18):
0 Evaluating the competency or objectivity of another party;

0 Obtaining an understanding about a particular subject; and
0 Interpreting documents outside the scope of the auditor's
professional expertise.
Findings and Report standards require independent accountants to present the results
Working of applying Agreed Upon Procedures to specific subject matter in the
Papers form of findings. Independent accountants should avoid vague or
ambiguous language in reporting findings.
The auditor should prepare and maintain working papers appropriate to

the circumstances to support the Agreed Upon Procedures engagement,
i.e., quantity, type, and content. Working papers should affirm that the
Page 5C-3
EXAMINER'S GUIDE
auditor adequately planned and supervised the work, and obtained

evidential matter to provide a reasonable basis for the finding. While
the working papers remain the property of the independent accountant
(in most jurisdictions), the auditor must maintain them for the
NCUA's review, consistent with requirements of Part 715 of the
NCUA Rules & Regulations.
Example of Following is a sample written finding of Agreed Upon Procedures as

Auditor's set forth in attestation standards (AT 201.32) and which may serve as
Written Agreed the product of this type of engagement:
Upon
Procedures To the Supervisory Committee and Board of ABC Federal Credit
Findings Union:
We have performed the procedures enumerated below, which were

agreed to by the supervisory committee and Board of ABC Federal
Credit Union, solely to assist you in connection with your supervisory
audit of ABC Federal Credit Union conducted pursuant to $715 of the
National Credit Union Administration Rules & Regulations. The
procedures performed by us and enumerated in the attached supplement
are in accordance with the minimum procedures described in Appendix
A of the National Credit Union Administration's Supervisory
Committee Guide for Federal Credit Unions. Because the committee is
responsible to ensure that a complete set of procedures is performed
and because Appendix A procedures are designed for smaller, less
complex credit unions, we performed other procedures at the
committee's request. This engagement to apply agreed-upon procedures
was performed in accordance with standards established by the
American Institute of Certified Public Accountants. The sufficiency of
the procedures is solely the responsibility of the specified parties.
Consequently, we make no representation regarding the sufficiency of
the procedures described in the supplement either for the purpose for
which this report has been requested or for any other purpose.
We were not engaged to, and did not, perform an audit, the objective of
which would be the expression of an opinion on the specified elements,
accounts, or items. Accordingly, we do not express such an opinion.
Had we performed additional procedures, other matters might have
come to our attention that would have been reported to you.
This report is intended solely for the information and use of [the
specified parties] and is not intended to be and should not be used by
anyone other than these specified parties.
[Signature of Independent Auditor]

[City, state]
[Date]
Page 5C-4
AGREED UPON PROCEDURES ENGAGEMENTS - APPENDIX 5C
References Federal Credit Union Act

- 115 - Supervisory Committee
- 715 - Supervisory Committee Audit
Supervisory Committee Guide
AICPA Audit and Accounting Guide (relevant to Credit Unions)
Page 5C-5
NON OPINION AUDITS - APPENDIX 5D
Non-Opinion In an audit performed by the supervisory committee or its designee, the
Audit Con- examiner looks for a critical and systematic examination of the internal
ducted by the controls, statements, records and accounting transactions prepared by
Committee or management. Unlike an audit performed by a CPA, professional
Its Non-CPA standards governing competence and independence do not govern this
Designee type of audit. Examiners use similar criteria for reviewing and
evaluating non-CPA audits as for reviewing and evaluating a CPA's
work.
An acceptable audit satisfies the requirements of NCUA Rules and

Regulations 5715.7 (c), Audit per Supervisory Committee Guide, in a
particular credit union. An unacceptable audit does not meet the
requirements. Exact acceptability standards for audits performed in
credit unions do not exist. Examiners must judge the risk and exposure
in each case to determine if an audit fulfilled the requirements of
NCUA Rules and Regulations Part 7 15.
Examiners must use certain standards in reviewing supervisory

committee work. Part 7 15 of the NCUA Rules and Regulations, the
Supervisory Committee Guide, and the supervisory committee section
of the Examiner's kuide contain information on these standards.
Appendix A, an important and key section of the Supervisory

Committee Guide, sets forth the minimum procedures for performing a
supervisory committee audit. Examiners should familiarize themselves
with the caution expressed in the Foreword language to the Appendix.
Also, as part of the review, the examiner should determine if the
supervisory committee properly documented the completed audit
procedures in working papers included in the audit or verification
report (see Working Paper Access section.)
In some cases, minimum audit procedures remain inadequate because

of the services or circumstances in a particular credit union. "High risk
areas" (e.g., cash operations, share drafts, ATMs, or when a credit
union experiences record keeping problems) may require expanding
procedures.
Page 5D-1
EXAMINER'S GUIDE
Areas experiencing unusual activity or volume, or those containing

recently added programs or requirements also may require expanding
audit procedures. For example, unusual activity might include
excessive amounts charged to officers' and directors' travel expenses
for a specific period. Unusual volume might include a 30 percent loan
to share ratio with the remainder of the assets invested. The first case
might require an expansion of the expense review; the second might
require an expansion of the investment review.
References NCUA Rules and Regulations

- 715 - Supervisory Committee Audit
Supervisory Committee Guide
Page 5D-2
Chapter 6
INFORMATION SYSTEMS AND TECHNOLOGY
TABLE OF CONTENTS
INFORMATION SYSTEMS AND TECHNOLOGY ..................................................... 6-1

Associated Risks .................................................................................................. 6. 1
Risk-Based Examination Considerations............................................................. 6. 1
Overview .............................................................................................................. 6.2
Processing Environment ...................................................................................... 6.3
Controls ................................................................................................................ 6.5
Management Controls .............................................................................. 6.5
General Controls ...................................................................................... 6.6
Application Controls ............................................................................... 6.8
Backup and Recovery .......................................................................................... 6.9
Contingency Planning .......................................................................................... 6-9
. . and Audits.......................................................................................
Examination 6. 10
Service Bureaus.................................................................................................... 6. 11
Outsourcing .......................................................................................................... 6.12
Security and Privacy ............................................................................................ 6. 13
Security .................................................................................................... 6. 13
Security Policies and Procedures ............................................................. 6. 14
Privacy ..................................................................................................... 6. 15
IS&T Questionnaires............................................................................................ 6. 15
CAMEL Impact ........................................................................................ 6. 16
APPENDIX 6A .INTERNET AND e-COMMERCE......................................... 6A-1
5-3 .3.
Chapter 6

Examination Evaluate management’s ability to recognize, assess, monitor, and
Objectives control information systems and technology (IST) related risks
0 Assess whether the credit union has sufficient expertise to
adequately plan, direct, and control IST operations
0 Determine whether the board of directors has adopted and
implemented adequate policies and procedures
Determine whether practices comply with established policies and
procedures
0 Determine adequacy of internal controls and oversight to safeguard
assets (including IST assets) and members’ information
Associated 0 Reputation risk stands out from the others primarily due to the
Risks risks associated with introduction of Internet services for credit
union members;
0 Transaction risk occurs when internal controls do not sufficiently
detect errors, omissions, or material misstatements;
0 Compliance risk occurs when inadequate systems and lack of
controls affects conformity with compliance laws and regulations;
and
0 Strategic risk occurs when management due diligence has not
sufficiently planned for unforeseen events.
Risk-Based When determining whether to perform a review of the IST function

Examination during an examination, examiners need to understand the associated
Consider- risks of the systems (hardware and software) used by the credit union,
ations the types of services provided, sensitivity of the data stored, and
controls implemented by the credit union to protect the systems and
data. Other considerations include:
Results of the last examination;

0 Recent external or internal audit results;
0 Results of most recent third-party review;
Page 6-1
EXAMINER'S GUIDE
0 Results of the most recent risk analysis andor penetration test, if

conducted;
0 Occurrence of security breaches or unauthorized access;
0 Filing of a claim or a loss related to IST;
0 Material change in services, key personnel, policies, or practices;
Material change in systems (hardware or software); or
0 Change in vendors which provide:
- Critical systems or services; or
- Support systems or services for critical systems or services.
Overview Examiners cannot consider reviewing a credit union's IST function as a

separate examination issue. Most credit unions tightly integrate their
information processing activities into the functional operation of the
credit union. For example, credit unions often use stand alone or
personal computers connected to a network to supplement integrated
IST functions for such things as audio response systems, loan
application and approval functions, credit report retrieval, budgeting,
payroll systems, website and e-Commerce systems. The nature and
complexity of IST processing may significantly increase the potential
risk exposure to disaster, error, or fraud within or outside the credit
union or service bureau operation. While the fundamental concepts of
internal control (e.g., separation of duties, audit trails, back-up,
monitoring, and contingency plans) remain the same in either a
computerized or manual system, the techniques and approach required
to review these systems differ.
The examiner's primary responsibility in reviewing IST operation is to

recognize the procedures and internal controls that minimize the
exposure to loss and disruption of service. The following conditions
may raise questions about the IST operations of the credit union:
A board or management unaware or uninterested in IST operations

and services;
Inadequate short- and long-term planning for computer operations;
Conversion to a new information processing system or
modification of an existing system since the previous examination;
Significant evidence of inefficiency or inaccuracy (e.g., slow daily
balancing, delayed closing of books, delayed distribution of
members' statements, inaccurate statements or records, etc.);
Page 6-2
Weak physical or internal controls; and

Negative comments by users (internal and external) of the systems.
Many credit unions use the Internet to provide financial services to

their members. This IST environment exposes a credit union to
external threats that previously were not an issue (see Appendix 6A for
a discussion on e-Commerce issues.) As a credit union’s IST
environment changes (vendor, hardware, or software), management
must re-evaluate the associated risks.
NCUA does not expect examiners to perform a detailed IST review.

Based on their judgment, examiners may request additional resources
such as an IS&T subject matter examiner (SME), regional office
analyst, or central office information systems officer (ISO) for needed
assistance. When determining the additional resources required, the
examiner should consider the following:
0 Associated risks;
0 Complexity of products and services;
0 Management experience and expertise;
0 Asset size; and
0 IST vulnerabilities (IST related losses or claims, system
penetration, unauthorized access, website defacements, etc.).
Credit unions or others (e.g., CUSOs, vendors) may occasionally ask

the examiner to express an opinion concerning specific hardware or
software systems for use in credit union operations. NCUA examiners
will not make recommendations concerning specific information
processing systems or services for purchase, lease, or contracting by
credit unions. Credit unions that purchase accounting services must
comply with the NCUA Rules and Regulations, $701.26, Credit Union
Service Contracts.
Processing Based on the physical location of the computer and the degree of credit
Environment union management control over the day-to-day operation of the
computer system, credit unions can classify their IST operations into
two broad categories:
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EXAMINER'S GUIDE
In-house processing means the computer is located on the credit

union premises and credit union management directs the day-to-
day operation of the computer. Distinguishing between the two
classes of in-house processing depends on the degree of credit
union involvement in the programming, system design, and
program maintenance efforts required for an on-going IST
operation:
- Turnkey systems are in-house processing systems for which a

credit union has no direct responsibility for programming,
system design, or program maintenance. Turnkey systems
include both the hardware and software necessary to process
credit union information. The credit union only furnishes
adequate space and personnel to operate the computer; an
outside party provides programming and continuing support.
The vendor supplying the turnkey system may also arrange
training for credit union staff using the system.
- User-designed systems are in-house processing systems for

which the individual credit union retains responsibility for
programming, system design, and program maintenance. Even
though the credit union may purchase the initial software for a
user-designed system, the vendor or systems designer will
modify it to meet the credit union's specific needs. Credit
unions may purchase hardware directly from the manufacturer
or a hardware vendor. The size of these systems can vary
widely; they are not limited to large mainframe computers.
Responsibility for programming and maintenance remains the

primary distinction between turnkey and user-designed data
processing systems.
0 Service bureau processing refers to information processing

services located away from the credit union and managed by an
outside party. Credit unions can obtain service bureau processing
from several sources, including:
- Another financial institution;

- A credit union service organization (CUSO);
Page 6-4
- An independent information processing vendor; or

- The credit union's sponsor.
Regardless of the processing source, the distinguishing characteristics

of outside processing include the physical separation from the credit
union's operations and the absence of direct management responsibility
for computer operations.
Controls IST controls prevent, detect, correct, and enable recovery from
problems that can result from accidents, errors, misuse, sabotage, loss
of equipment, loss of data, and any other occurrence that may lead to
an unwanted or unexpected disruption of service. The three major
categories of IST controls are (1) management controls, (2) general
controls, and (3) applications controls.
Management The examiner should have a good understanding of how a credit union
Controls manages its information system and services. Similar control issues
exist for this area as for those generally found in other operational
areas, and they require similar review procedures. Good IST
management includes the following:
0 Organization. A credit union should have a well-defined

organizational structure that includes the IST department or service
area. Ideally, credit unions should establish IST as a separate entity
that reports directly to management and not through another
department. The IST department should maintain an up-to-date
topology (a visual representation of the hardware layout) to
describe how various systems interact and share data.
Planning. The credit union's short- and long-term plans should

identifj management's direction regarding its IST operation.
Management should regularly document, update, and review these
plans, which should include well-thought-out designs for
installation of new systems and the modification of existing ones.
Effective planning includes input from various sources such as a
team with representatives from senior management, information
technology, human resources or personnel, legal, and customer
Page 6-5
EXAMINER'S GUIDE
service. A diversified team allows for different perspectives in

development of IST plans and effective policies and procedures.
0 Policies and Procedures. The credit union should have well-

documented policies and procedures for the IST operation.
Management should review and update written procedures
regularly. Documentation should reflect the actual practices at the
credit union.
0 Monitoring Operations. The crucial oversight function of IST

operations can involve the use of committees such as an IST
management committee, IST steering committee, or the
supervisory committee.
0 Audit. Auditing the IST area is a cost of doing business. Credit

unions should require regular internal and external reviews of IST
operations and services. IST audits or reviews will differ from one
credit union to another based on the importance of IST services to
the credit union and the credit union's size and complexity.
External Requirements. Credit unions must comply with the laws,

regulations, and guidelines of various governmental and regulatory
bodies (international laws, federal and state regulations, etc.) as
they pertain to the IST operations (see Appendix 6A.)
General Controls General controls apply to areas of an information processing system

not specifically related to any one application or function. General
control issues exist in any automated environment and remain essential
to the proper day-to-day operation of an information processing
system. Proper general controls address the following issues:
0 Organizational. Credit unions should establish and maintain

separation of duties, a key element of any IST operation. In an IST
environment, good internal controls prevent any single employee
from having control over the input, processing, and output of
transactions. Compensating controls, such as frequent and detailed
review of transaction logs, can help offset weaknesses in this area.
Page 6-6
Management should also address other important concerns of an

IST environment including personnel issues, such as employment
procedures, job descriptions, security statements to help control
data, and termination procedures.
0 Systems Design, Development, Modification, Testing, and

Implementation, commonly referred to as System Development
Life Cycle (SDLC). Credit unions should document the methods
and procedures for developing and testing new and enhanced
systems. Implementing these procedures will help maintain the
integrity of programmed applications.
Data Center Management. The operation of the data center

includes, among other things, the control and scheduling of input
and output, problem prevention and correction, and reporting.
Credit unions should thoroughly document procedures and
regularly update them.
0 Software Controls. Credit unions must control access to software

by unauthorized persons, especially the control and use of the
operating system, software utilities, communications, and security
packages. Control of production application software helps ensure
the system's integrity. System logs are useful tools for monitoring
activity and changes to the system if management produces and
reviews them regularly.
0 Hardware Controls. Credit unions should document and enforce

external controls on hardware such as access controls, terminal
usage, and system support and service. Computers have internal
hardware controls, such as validity, parity, and echo checks that
most users do not see, however, these hardware controls monitor
and check for proper hardware function.
0 Physical Security. The computer room or area should demonstrate

evidence of physical controls such as access controls and logs, fire
and theft protection, terminal access controls, and protection of
data files and media. Log-on procedures, such as user IDS,
passwords, and physical or electronic keys may provide additional
access control to the system.
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EXAMINER'S GUIDE
0 Contingency Plan. The ability to retain, restart, and replace

information processing activity quickly is an important control
feature of an information processing system. Keys to a well-run
and controlled IST operation include a written and tested
contingency plan, proper backup and recovery actions and
procedures, and management's commitment to contingency
planning.
Application Application controls apply to the processing of data into, through, and
Controls out of the computer system. An awareness of IST controls enhances
the review of automated parts of the process. While examiners do not
extensively review application controls, conditions at the credit union
may warrant an applications review. In these situations, the examiner
should recommend that management obtain a third-party review.
Application controls consist of the following:
0 Data Origination. Credit unions should design source documents

for easy and accurate data input. Management should properly
authorize data before staff enters it into the system. Basic controls
of data origination include batch totals, control totals, turnaround
documents, and retention of source documents.
Data Input. Controls of data input involve conversion, validation,

editing, error handling, and separation of duties.
Data Processing. External data processing controls maintain the

operation of the system until completion of the application
processing. These controls include system start-up procedures,
backup and emergency procedures, error message debugging, and
system and job status reporting. Internal processing validation and
editing routines built into the programming check for errors. Upon
completion of processing, the credit union should have in place
error handling procedures to identify and correct transaction errors.
Data Output. Management or staff should use all output from the
system. Balancing and reconciliation, distribution, error handling,
and records retention procedures (see NCUA Rules & Regulations
$749 - Records Preservation Program And Record Retention
Appendix) complete the application processing function.
Page 6-8
Backup and A multitude of problems that may cause breakdown, damage and other
Recovery detrimental effects can plague computer systems. Users may question
the integrity of the data in the system when problems occur. Credit
unions must regularly and routinely back up computer data. Following
are several considerations involved in the backup and recovery of
computer information:
Frequency. Credit unions should back up (1) data files at least

daily; (2) application files both when they make changes and
routinely, usually monthly or quarterly; (3) a current copy of the
operating system, and (4) vital records every three months.
Generations. Credit unions should have available at least three

generations of backups; however, many credit unions keep five sets
of data file backups, one made on each day of the week.
Storage. Credit unions must store vital records offsite, at a location

far enough from the credit union’s offices, to avoid the
simultaneous loss of both sets of records. Credit unions should
keep backup files both on- and off-site, one set of backups at each
location, in order to facilitate recovery of operations should an
event occur.
Management. Credit unions should routinely control, maintain, and

test backup files for quality and accuracy.
Recovery. Credit unions should address and document relevant

issues such as the speed of data file recovery, who can recover
them, and under what conditions.
Contingency Restoring operations to an acceptable level within a reasonable amount

Planning of time requires that all credit unions using any type of IST services
have a comprehensive, written, accurate, up-to-date, tested
contingency plan. Responsibility for developing this plan lies with
management. The examiner may review the contingency plan during
each examination.
Credit unions should develop detailed contingency plans. These plans

should take into account local as well as region-wide disasters.
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EXAMINER'S GUIDE
Contingency plans should also consider any single point of failure

issues (such as telecommunication and data lines, electrical services,
etc.) Management should routinely test the contingency plan and
document the results of those tests. Where the testing process identifies
a failure or weakness, management should correct those issues and
retest the plan. Management should ensure the contingency plan
addresses the following considerations:
Notification and contact procedures (staff, vendors, federal

agencies, state agencies, local authorities, members, other
appropriate third parties, etc.);
Hardware and software requirements and needs;
Timeframes, including acceptable downtime for the credit union
and the time needed to bring processing services up after a disaster;
Critical, priority, and support systems;
Backup and recovery of operating system, application software,
and data files;
Current written documentation;
Alternative sites for processing;
Communications needs (telephone lines, fax capabilities, cell
phones, data lines (Tl, T3, fiber optic, etc.) and capabilities
(bandwidth and throughput);
Employees' knowledge (understanding of their duties and needs)
and training;
Administrative needs and supplies;
Insurance coverage and requirements;
Security for the credit union and the alternative sites; and
Testing.
Examination The examination and audits of the information processing and

and Audits services, including both internal and external reviews, give the credit
union assurance that the system's design and operation function as
intended. Internally, the credit union should perform, at a minimum,
quality and accuracy checks on the system's processing to ensure the
presence of at least the minimum control requirements for the type of
system in use. Depending on its size, type of system, and complexity, a
credit union may need a complete third-party audit. Larger credit
unions may need an internal IST auditor to perform routine, recurring
reviews of the system.
Page 6-10
Based on the risk-focused examination considerations discussed earlier

in this chapter, examiners may perform some level of IST review
during the examinations of credit unions having automated systems.
Most credit unions rely on automated systems. Many credit unions
could not operate at their present service level without these systems.
The audit software available in AIRES allows for sampling and
querying share and loan data. A download from the credit union’s
system helps the examiner analyze the data in the computer system by
allowing the examiner to compare AIRES results with the credit
union’s reports. Examiners can review records for quality,
completeness, and accuracy. Additionally, examiners can compare data
from separate sources for consistency, and can summarize and sort
data in various ways.
During the IST review, examiners should perform a review of IST

management and general controls. Examiners can address review
results in one or more of the following ways:
No recommendations, based on the quality and acceptability of the

review;
Recommendation that management improve certain areas of the
IST operation or services;
Recommendation that management obtain a partial or complete
third-party review; or
0 Notification to the supervisory examiner of extensive problems in
the system.
Service Credit unions that use service bureau operations (also called service
Bureaus centers) to process their information have many of the same
responsibilities as those using in-house services. Management can
make a serious mistake by relying heavily on a service bureau without
providing adequate oversight. Management should recognize and
monitor important issues including ownership and control of data,
timeliness, accuracy and completeness of information processing
functions, contractual obligations, contingency planning, backup and
recovery of data files, financial stability of the service bureau, and
service bureau audits (financial, SAS 70, etc.)
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EXAMINER'S GUIDE
Examiners should pay particular attention to the contract between the

service bureau and the credit union. A written contract must specify
responsibilities of both parties. Credit union management must
understand the contents of the contract with the service bureau. The
provisions often contained in an IST service contract include:
Specific work that the service bureau agrees to perform, and the
frequency and general contents of the related reports;
The basis of costs, including development, conversion, and
processing, together with additional charges for special requests;
Established time schedules for receipt and delivery of work;
Audit responsibility, including the right of user representatives to
perform audit procedures (such as a SAS 70 Report);
Backup and record protection provisions (equipment, program, and
data files) to ensure timely processing by the service bureau in
emergencies;
Establishment of liability for source documents while in transit to
and from the service center (the service center should have
adequate insurance coverage for those liabilities for which it bears
responsibility);
Maintenance of adequate insurance for data losses from errors and
omissions;
Confidential treatment of records;
Ongoing compliance with federal regulations;
Ownership and escrow of computer programs and related
documentation;
Ownership of master and transaction data files and their return in
machine-readable format upon the termination of the contract or
agreement;
Price changes, cost and method of cancellation of the contract, or
withdrawal from the servicing arrangement by either party,
including adequate time allowance;
Notification from the service center to the users of all systems of
changes that would affect procedures, reports, etc.; and
Financial information that the service bureau agrees to provide
periodically (preferably at least annually) to credit unions.
OUtSOUrCing Credit unions often rely on third parties to provide and support
technology-related functions and services. Outsourcing arrangements
Page 6-12
can help manage costs, provide expertise, and expand and improve
services offered to members. The credit union may outsource the
system or service; however, management ultimately remains
responsible for managing the risks associated with the system or
service. The following four key points pertain to managing outsourced
technology:
The board of directors and senior management bear responsibility

for understanding the risks associated with outsourcing
arrangements for technology services and ensuring implementation
of effective risk management strategies and practices;
Once the credit union has completed its risk assessment and
determined its risk acceptance level, management should evaluate
service providers to determine their operational and financial
abilities to meet the credit union’s needs;
Credit unions should require clearly written and sufficiently

detailed contracts that provide assurances for performance,
reliability, security, confidentiality, and reporting; and
Credit unions should implement an oversight program to monitor

each service provider’s operations and controls, financial
condition, and performance standards.
(For a more in depth discussion on outsourcing, see NCUA Letter #OO-

CU- 11, Risk Management of Outsourced Technology Services.)
Security and NCUA developed the security and privacy guidelines in $716 and
Privacy revised $748 of the NCUA Rules & Regulations in response to the
Gramm-Leach-Bliley Act (GLBA).
Security NCUA Rules and Regulations 5748.0 requires each federally-insured

credit union to develop a written security program. This program must
strive to:
Protect each credit union office from robberies, burglaries,

larcenies, and embezzlement;
Page 6-13
EXAMINER'S GUIDE
Ensure the security and confidentiality of member records, protect

against anticipated threats or hazards to the security or integrity of
such records, and protect against unauthorized access to or use of
such records that could result in substantial harm or serious
inconvenience to a member;
Assist in the identification of persons who commit or attempt such
actions and crimes; and
Prevent destruction of vital records, as defined in 5749.
The appendix to 5748 provides guidelines to assist credit unions in

meeting the above four criteria. The guidelines, while not mandatory,
provide a good framework from which credit unions can work to
develop their policies and procedures.
Security Policies Credit unions may find the following considerations useful when
and Procedures developing security policies and procedures:
Identifying the services provided and systems (hardware and

software) used;
Identifying the risks and threats associated with each system and
service;
Determining the likelihood the risk or threat could occur;
Identifying and evaluating various methodologies to mitigate the
risks or threats;
Developing the policies and procedures to address the risks or
threats;
Monitoring, and adjusting if necessary, the policies and procedures
to achieve the desired results;
Reviewing policies and procedures at least annually; and
Training and educating staff.
Though not required, credit unions should establish a security team

assigned with the responsibility of developing, implementing,
monitoring, and revising security policies and procedures. Team
members should include representatives from senior management,
information technology department, human resources or personnel
department, legal department, and customer service department. A
diversified team will provide input from different perspectives in
Page 6-14
development of effective policies and procedures (see NCUA Rules

and Regulations $748 and Appendix).
If a credit union demonstrates a weakness in one or more of the

preceding steps, examiners should address that concern in a manner
consistent with the risk and potential effect on the credit union.
Privacy Credit unions must ensure their IST policies, procedures, practices,
systems design, and operations comply with the privacy requirements
in NCUA Rules and Regulations $7 16 (see NCUA Letter #O 1-CU-02,
Privacy of Consumer Financial Information for a detailed discussion.)
Credit unions must also work with their vendors to ensure that their
vendors comply with the credit union’s privacy statements.
IS&T AIRES contains three questionnaires to assist the examiner in

Question - performing and documenting the IST review. The purpose and
naires description of each questionnaire is:
0 e-Commerce I (EC 1). EC I is a high-level questionnaire designed

to assist examiners in their review of credit union e-commerce
services. EC I primarily focuses on credit union management’s
actions regarding the planning, implementation, and oversight of e-
commerce systems and services;
e-Commerce I1 (EC2). EC2 is a detailed questionnaire designed to

assist examiners in conducting an in-depth review of e-commerce
systems and services. Generally, examiners use EC2 when the
results of ECl indicate problems or issues exist which, in the
examiner’s judgment, warrants further review. EC I and EC2 have
eleven identical major sections allowing examiners to identify
concerns using EC1 and then use the corresponding section in EC2
to perform additional examination procedures as warranted.
Examiners also use EC2 in large and complex credit unions; and
0 Electronic Data Processing Review (EDPR). EDPR is a technical

questionnaire designed to assist examiners in their review of credit
union IST systems. Generally, examiners use EDPR when they
wish to perform a review of a credit union’s automated systems
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EXAMINER'S GUIDE
(not just e-Commerce) or, when in their judgment, a review is

warranted due to:
- Significant weaknesses noted in IST areas;

- Lack of an adequate internal or external review program for
IST systems;
- Lack of adequate management oversight, risk analysis, or risk
control;
- Lack of adequate policies, procedures, and practices; or
- EC 1 and/or EC2 review results reveal IST concerns regarding
e-Commerce systems and services (if concerns exists for e-
Commerce systems and services, similar concerns may exist for
core processing systems and services.)
CAMEL Impact Examiners should use the Management component of the CAMEL
rating to address IST concerns. As part of this assessment, examiners
should consider the following:
0 Strategic Plan & Goals:
- Has management developed a strategic plan for the credit

union's IST systems and services?
- Has management developed strategic goals, policies, and
procedures to implement the strategic plan?
- Are those strategic goals, policies, and procedures adequate in
relation to the following:
i. Size and complexity of the credit union;

ii. Type of services offered;
iii. Volume of IST activity;
iv. Member demand, usage, and expectations; and
v. Criticality' of systems and services?
Management should determine whether IST systems and services are critical or
non-critical to the credit union's operations. Management should base this
determination on factors such as, but not limited to, the following: risk exposure
(transaction, security, compliance, reputation, etc.), type of services offered,
transaction volume (number and dollar), interconnectivityimpact with other credit
union technology systems, member usage, and member expectations and perceptions.
Page 6-16
0 Risk Analysis:
- Has management performed a risk analysis? If so, does the

analysis include the following components:
i. Assessment;
..
11. Impact analysis/evaluation;
iii. Mitigation;
iv. On-goingperiodic monitoring; and
v. Reporting procedures?
0 Policies:
- Has management developed appropriate and adequate policies

that address the following:
i. Security;
..
11. Compliance;
iii. Business continuity/resumption;

iv. Disaster recovery; and
v. Vendor management?
0 Oversight:
- Does management provide adequate oversight including:
i. Adequate staffing;
ii. Knowledgeable/informed staff (in IST activities); and
iii. Adequate reporting procedures at various management
levels?
- Has the internal and/or external review program been modified

to include reviewing procedures for IST activities?
- Does management address issues/concerns effectively,

adequately, and timely?
- Does management have adequate vendor oversight policies,

procedures, and practices?
Page 6-17
EXAMINER'S GUIDE
Workpapers Workpapers
and - Electronic Data Processing Review (EDPR)
References - E-Commerce I (EC1)
- E-Commerce I1 (EC2)
0 References
- Federal Laws/Regulations
Computer Fraud and Abuse Act (CFAA)
Electronic Funds Transfer Act (EFTA, REG E)
Expedited Funds Availability Act (EFAA, REG CC)
Child On-Line Privacy Protection Act (COPPA)
Gramm-Leach-Bliley Act (GLBA)
Electronic Signatures in Global and National Commerce
Act (E-Sign)
..
701.26 - Credit Union Service Contracts
..
7 12 - Credit Union Service Organizations
7 16 - Privacy of Consumer Financial Information
721 - Federal Credit Union Incidental Powers
748 - Credit Security Program, Report of Crime and
Catastrophic Act and Bank Secrecy Act Compliance
749 - Records Preservation Program And Record Retention
Appendix
- Regulatory Alerts
01-RA-07 Children 's Online Privacy Protection Act
(COOPA)
0 1-RA-06 Regulation E (Electronic Fund Transfers)
0 1-RA-03 Electronic Signatures in Global and National
Commerce Act (E-Sign Act)
00-RA-0 1 Electronic Transfers Accounts
98-RA-08 Electronic Transfer Act
98-RA-04 Interagency Guidance on Electronic Financial
Services and Consumer Compliance
97-RA- 12 Guidancefor Reporting Computer-Related
Crimes
.
- Letters To Credit Unions
0 1-CU-04 Integrating Financial Services and Emerging
Technology
Page 6-18
8 0 1-CU-02 Privacy of Consumer Financial Information

8 00-CU- 11 Risk Management of Outsourced Technology
Services
8 00-CU-09 AIRES 2000 Loan and Share Record Layout
Specijkations
8 00-CU-07 NCUA s Information Systems & Technology
Examination Program
8 00-CU-04 Suspicious Activity Reporting
8 00-CU-02 Identity Theft Prevention
8 98-CU- 12 Business Resumption Contingency Planning
8
98-CU-02 Year 2000 Contingency Planning
rn 97-CU-05 Interagency Statement on Retail On-line PC
Banking
8 97-CU-03 Corporate Business Resumption and
Contingency Planning
8 97-CU-0 1 Automated Response System Controls
8 96-CU-04 Internal Control Structure
8 109 Information Processing Issues
- FFIEC Information Systems Examination Handbook
- Websites
Cybercrime: http://www.cybercrime.gov/
Computer Crime and Intellectual Property Section
(CCIPS):
http ://www.usdoj.gov/criminal/cybercrime/compcrime.html
#CC
Federal Computer Incident Response (FedCIRC):
http://www.fedcirc. gov/
Financial Crimes Enforcement Network (FinCen):
http ://www.treas.gov/fincen/
Federal Trade Commission (FTC): http://www.fic.gov/
Internet Fraud Complaint Center (IFCC):
https://www.ifccfbi.gov/
National Infrastructure Protection Center (NIPC):
http://www.nipc.gov/
Electronic Privacy Information Center (EPIC):
http://www.epic.orgl
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EXAMINER'S GUIDE
Incidentsorg-By The SANS Institute:

http://www.incidents.orgl
Internet Security Systems, Inc.: http://www.iss.net/
National Institute of Standards and Technology Resource
Center: http://csrc.ncsl.nist.gov/
SecurityFocus (BugTraq): http://www.securityfocus.com/
CERT@ Coordination Center: http://www.cert.orgl
Internet Fraud (IFW):
http://www.fraud.org/internet/intset.htm
Information Technology Association of America:
http://www.itaa.orgl
SANS Institute Online:
http://www.sans.org/newlook/home. htm
Security & Exchange Commission-Division of
Enforcement - Complaint Center:
http://www.sec.gov/enforce/comctr.htm
Page 6-20
INTERNET AND e-COMMERCE APPENDIX 6A -
Overview Many credit unions offer services to members via electronic means,
often through the Internet and World Wide Web. Electronic financial
services pose inherent risks to credit unions. Management must
understand those risks and take measures to mitigate them.
Electronic financial services (EFS) comprise those services that a

credit union provides via electronic means including, but not limited
to, the following:
0 Electronic Commerce Systems and Services:
- Internet/World Wide Web services;

- Home Banking (direct dial in) Services;
- Wireless Services;
- Audio Response/Phone Based;
- Kiosk; and
- e-Commerce Account Transaction Processing Services. Online
e-Commerce account services include, but are not limited to,
the following:
i. Account Inquiry;
ii. Check Order Requests;
iii. Loan Applications;
iv. Bill Payment;
v. Funds Transfers;
vi. Third-Party Transfers;
vii. Stop Payment Requests;
viii. On-Line Wire Transfers;
ix. Automated Clearing House (ACH) Originations; and
x. Account AggregatiodScreen Scraping.'
Account aggregation and screen scraping are two different methods used to gather
user account information from various sources and then compile that information in
one location for the user.
Page 6A-1
EXAMINER'S GUIDE
0 Electronic Payment Systems:
- ACH Transactions;
- Stored Value Cards;
- Electronic Money; and
- Electronic Wallets.
0 ATM Systems.
There are three types of website systems:
0 Informational. An Informational system displays general

information such as loadshare rates, credit union contact
information, and privacy notices;
0 Interactive. An Interactive system contains features of an

Informational website plus members can request information SUL
as share balances, loan balances, account statements, and
disclosure statements. Members can complete loan applications,
member applications, share account applications, etc.; and
0 Transactional. A Transactional system contains features of an

Interactive website plus members can initiate and perform
transactions such as paying bills, making loan payments,
transferring money or funds (between one or more credit union
accounts; between the credit union and third-parties), and opening
new share accounts.
The introduction of website services (whether hosted internally or

externally) exposes a credit union to increased risk. In addition, the
type of website affects the level of risk the credit union assumes (i.e.,
transactional websites generally have a higher level of risk than an
interactive website.)
The following four tools will assist examiners in their risk-based

approach to evaluating credit union management in the area of
electronic financial services:
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INTERNET AND e-COMMERCE - APPENDIX 6A
0 e-Commerce I (EC 1) - high level e-Commerce questionnaire;

0 e-Commerce I1 (EC2) - detailed review program for reviewing a
credit union’s e-Commerce activities;
0 EDP Review (EDPR) - Electronic Data Processing Review
Program for reviewing a credit union’s overall information and
technology systems; and
Computer Desktop Encyclopedia computer disk.
AIRES contains the first three tools. The Computer Desktop

Encyclopedia is on a computer disk with updates issued periodically
throughout the year.
Threats Credit unions that provide web-based services face additional threats
and Vulner- and vulnerabilities. Generally, these concerns arise because the credit
abiI ities union has adopted an “open environment.” This is one in which
external parties have access to one or more of the credit union’s
internal systems. Typical threats and vulnerabilities associated with the
Internet and web-based services include:
Eavesdropping or Packet Sniffing;

Snooping or Downloading;
Tampering;
Spoofing;
Jamming or Flooding (Distributed Denial of Service (DDoS));
Injecting Malicious Code (viruses and Trojan Horses);
Exploiting Flaws; and
Cracking.
Effective policies, procedures, and practices, which address the

following, provide the best way to deal with these threats and
vulnerabilities:
0 Risks assessments;
0 Security measures;
Monitoring requirements;
0 Incident response procedures;
0 Vendor oversight; and
Contingency planning and business resumption contingency planning.
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EXAMINER’S GUIDE
Risk The credit union should have implemented a risk assessment procedure
Assessments that enables it to do the following:
0 Identifjr the threats and vulnerabilities;

0 Assess the risk (likelihood of occurrence and effect on credit
union);
a Establish risk tolerance thresholds (how much given risk is the
credit union willing to assume);
0 Implement risk mitigation strategies; and
0 Monitor and adjust, as needed, risk mitigation strategies on a
regular basis.
Security The types of security measures a credit union employs depends on the
Measures types of systems and services it provides, the complexity of those
systems and services, the credit union’s risk tolerance thresholds, and
the experience of IST management. NCUA Rules & Regulations $748
delineates the security requirements credit unions must meet and
provides guidelines they may employ to meet those requirements. A
business decision by the board addresses how the credit union will
implement security for its systems and data. When providing web-
based services, best practices suggests using the following:
Routers (to route data to the appropriate destination);

Firewalls (to filter incoming and outgoing traffic);
Virus protection (to prevent or control viruses and Trojan horses);
Intrusion detection (to alert management when an intruder is
attempting to breach, or successfully has breached, the credit
union’s perimeter security systems);
Vulnerability assessments and penetration testing (to identify and
determine weaknesses associated with individual systems and the
IST environment as a whole);
Security bulletin and alert monitoring (to remain aware of new
security issues and install new updates and patches in a timely
manner);
Incident response procedures and employee training (to limit
damage once an incident has occurred); and
Vendor oversight program (to ensure vendors and contracts meet
the credit union’s minimum requirements.)
Page 6A-4
Monitoring Each credit union should establish monitoring requirements for all
Requirements phases of its IST activities, from monitoring internal systems (e,g.,
systems log reviews) to monitoring the operations of the vendors.
Monitoring procedures allow a credit union to determine what works
and what does not. This provides management the ability to make
appropriate adjustments to policies, procedures, and practices.
Incident The credit union’s incident response plan should provide assurance
Response that the credit union has the ability to deal with various types of
Procedures incidents within reasonable timeframes, thus minimizing the risk of
loss. Key factors for dealing with incidents include (1) what action to
take, (2) when to take it, and (3) how to implement that action. The
amount of detail in a credit union’s incident response plan should
relate to the size of the credit union, the complexity of its operations,
and the structure of its IST environment. For example, a credit union
operating in a complex in-house developed IST environment would
have a different incident response plan from a credit union solely
operating in an outsourced environment.
Vendor A credit union should establish a vendor oversight program that

Oversight ensures its vendors meet pre-established criteria such as security and
privacy. The credit union should carefully review its vendor contracts
to ascertain each party’s rights and obligations and to ensure that
service level agreements meet the credit union’s expectations and
needs. If available, credit unions should obtain and review vendor
financial statements to determine the short- and long-term viability of
their vendors. The credit union should decide whether obtaining a copy
of a vendor’s SAS 70 or other audit report (if available) would assist in
determining the quality of the vendor’s management, various controls,
policies, procedures, and practices. Credit unions should regularly
communicate with their vendors to obtain current information
regarding the vendors’ hardware and software systems.
Contingency A credit union should determine the importance of its web-based

Planning and services and products to its operations. Based on the level of criticality,
Business the credit union needs to develop appropriate procedures to ensure an
Resumption incident or disaster will minimally impact, or impact only to a
Page 6A-5
EXAMINER’S GUIDE
predetermined acceptable level, member services and credit union

operations. Occurrence of an incident or disaster can result in
reputation risk, a risk that credit unions commonly overlook.
Therefore, credit unions should address not only the disruption of
services and potential financial loss (volume and dollar transactions),
but also the long-term costs to their reputation and the industry.
Bond Credit unions should have implemented a risk management program to

Insurance manage the risks inherent in their operations. Insurance can play a role
Coverage in mitigating risks to an acceptable level so the credit union can
achieve its strategic objectives.
NCUA Rules and Regulations $713, Fidelity Bond and Insurance

Coverage for Federal Credit Unions, requires that each federal credit
union board review its insurance coverage for adequacy in relation to
the potential risks facing the credit union. The board must review the
insurance coverage at least annually. A thorough risk assessment
process would help determine the adequacy of the coverage in relation
to the credit union’s activities, including e-Commerce.
A credit union should reevaluate insurance needs whenever it

considers a new product, service, or vendor relationship. These may
introduce new risks for which insurance coverage may require
modification.
Risks associated with e-Commerce are wide-ranging. An insurance

carrier’s product offerings may cover these risks in various places such
as the fidelity bond, electronic computer crime coverage, and other
optional coverage. The credit union and, if necessary, the examiner
should review each type of coverage closely to determine its adequacy
in relation to the credit union’s risk exposure. The following types of
insurance may cover EDP activities:
Fidelity bond coverage principally covers the direct loss due to a

physical crime such as theft of certain defined property (e.g.,
negotiable items) stolen by a first party (e.g., employee from an
employer);
Page 6A-6
Electronic computer crime coverage fills some of the gaps in

fidelity bond coverage. It typically covers the direct loss due to an
electronic computer crime resulting in the loss of defined property
(e.g., negotiable items). Moreover, it can cover the risk of viruses
and the manipulation or destruction of data and programs; and
0 Other optional coverage fills some of the gaps in the fidelity and
electronic computer crime coverage. These may cover indirect
losses (e.g., business interruption or resumption and extortion) and
expand defined property to include confidential member and credit
union data. Some may cover additional related liabilities or
expenses (even in relation to external service providers and
litigation.)
Coverage varies among insurance carriers. Moreover, carriers often

bundle their insurance offerings in different packages with unique
marketing names. The coverage afforded by these policies may change
in the future based on the insurance industry’s perceived risk and
claims experience.
Page 6A-7
IDA - d &
Chapter 7
MANAGEMENT
TABLE OF CONTENTS
MANAGEMENT............................................................................................................. 7-1
Examination Objectives ....................................................................................... 7. 1
Overview.............................................................................................................. 7-2
Meeting with Management ................................................................................. 7-2
Board, Committees, Operational Management.................................................... 7-4
Red Flags ................................................................................................. 7-5
Board Responsibility . . . ................................................................................ 7-6
Board and Committee Minutes ................................................................ 7-7
Annual Meeting ....................................................................................... 7-9
Board Appointment .................................................................................. 7-9
Operating Management ........................................................................................ 7-10
Policies and Procedures ........................................................................... 7-10
Board Oversight of Operating Management ............................................ 7-11
RisWReturn Tradeoff ............................................................................... 7-12
Financial Management ............................................................................. 7-12
Personnel Management ............................................................................ 7-13
Service to Members ................................................................................. 7-14
Planning ............................................................................................................... 7-15
Strategic Planning .................................................................................... 7-16
Business Plan ........................................................................................... 7-17
Net Worth Restoration Plan ..................................................................... 7-19
Material Contracts.................................................................................... 7-20
Executive Compensation ......................................................................... 7-20
Unsafe and Unsound Compensation Practices......................................... 7-22
Directors' Conduct ............................................................................................... 7-23
Conflicts of Interest .................................................................................. 7-24
Use of Consultants ................................................................................... 7-25
Political Contributions ......................................................................................... 7-25
Other Areas of Review ......................................................................................... 7-26
Internal Controls .................................................................................................. 7-27
Fidelity Bond and General Insurance ................................................................... 7-29
FIRREA Requirements for New or Troubled Credit Unions...................7-32
Incompetent or Inefficient Management .................................................. 7-33
Chapter 7
MANAGEMENT
Examination Assess management’s ability to recognize, assess, monitor, and
Objectives control risk
Assess whether the credit union board of directors has sufficient
expertise to adequately plan, direct, and control the operations of
the credit union
Determine whether the board and management adequately plan for
future conditions and developments
Determine whether the board is appropriately fulfilling its
responsibilities and duties
Determine whether the board has adopted adequate policies and
operating strategies to conduct prudent credit union operations
Determine whether the board establishes appropriate limits and
provides direction before offering a new service or product
Determine whether operating management has developed
procedures to implement board policy
Determine whether management performs due diligence on new,
existing, and planned products and services
Determine whether management has implemented adequate
internal controls to ensure the sound operation of the credit union
Determine whether management appropriately reports credit union
operations and risk information to the board
Determine promptness of corrective action initiated by
management when deficiencies or violations in policies, practices,
procedures, or internal controls arise
Associated Management affects all seven risks found in credit union operations -
Risks credit, interest rate, liquidity, transaction, compliance, strategic, and
reputation. (The Risk-Focused Program chapter contains a description
of the seven risks faced by
EXAMINER’S GUIDE
and internal/external audit reports, and (3) allocate the necessary

resources to adequately manage the credit union in a safe and
sound manner;
0 Compliance risk occurs when the credit union fails to adhere to
0 Reputation risk occurs when management fails to meet its fiduciary
duties, resulting in poor publicity or administrative action.
Overview Management is responsible for identifying, monitoring, measuring and

controlling (i-e., managing) the risks faced by the credit union. Their
ability to manage these risks determine whether the credit union can
correctly diagnose and respond to financial stress. Examiners should
not assess management solely on the credit union’s current financial
condition, nor should the management rating be only an average of the
other component ratings.
Meeting with Examiners should complete the credit union update questionnaire for
Management guidance in reviewing credit union management, especially when the
examiner begins examining the credit union. Examiners may use the
list of topics in this section to discuss, observe, and analyze the
effectiveness of management. When acquainting themselves with the
credit union’s activities, the list may aid examiners in engaging the
managing official (often the chief executive officer or CEO) and other
management in discussions about their respective areas of
responsibility. This may assist the examiner in assessing
management’s effectiveness.
Examiners should conduct a preliminary interview with senior

executive officials to discuss items such as the credit union’s
operations, strategic plan, products, and services. Responses to certain
topics or the examiner’s observations may trigger expansion of
examination scope and, if necessary, corrective action.
The following list is not all-inclusive. Examiners must use their

judgment if their observations direct them toward exploring other
topics. Depending on the size, complexity, risk profile, and
organizational structure of the credit union, examiners will discuss or
Page 7-2
MANAGEMENT
observe the following or similar matters with the appropriate

management staff:
Key personnel changes since the previous examination and future

plans;
Significant new or planned programs or services, as well as the
extent to which members use existing products and services;
Due diligence performed by management on new and planned
programs and services;
Significant acquisitions of new facilities and future plans;
EDP conversions, upgrades or material changes;
Problems with the sponsors and the field of membership;
Working relationship with the board of directors;
Material change in the investment portfolio and future plans;
Material change in the loan portfolio and future plans;
Recordkeeping issues (e.g., balanced general ledger, balanced
individual share and loan ledgers, cash reconcilements);
Off-balance sheet risk areas;
Lawsuits or other contingent liabilities;
Material changes in key policies or procedures, and future plans
regarding policies and procedures;
Return on assets, capital accumulation strategy, meeting goals;
Management succession plan;
Systematic review of policies and procedures;
Frequent need for borrowed funds;
Ground rules for dealing with department heads and other staff;
and
Procedures for daily management discussions.
To review credit union management, examiners may consider the

following procedures:
Review the credit union’s strategic and business plans and analyze
management’s integration of risk management with planning and
decision making;
Review responsiveness to examination and audit suggestions and

recommendations, and assess corrective actions taken to address
risks identified in prior examinations and audits;
Page 7-3
EXAMINER’S GUIDE
0 Review the minutes of regular and special board and committee

meetings for significant items;
0 Review policies and procedures in each area of operation (e.g.,

lending, investment, personnel, etc.) and ensure that the policies
and procedures are updated at least annually;
Review the credit union’s budget, budget assumptions, and budget

variance analysis (budgeted items against actual performance);
0 Review documentation of management’s due diligence regarding

existing, new, and planned products and services;
0 Review the adequacy of the allowance for loan and lease losses and
other valuation reserve accounts;
0 Review material contracts signed by management since the last

examination; and
0 Review and analyze the supervisory committee’s annual work plan,

including the audit and verification programs and internal control
procedures, using the Supervisory Committee Audit and
Verification Review questionnaire, to help determine the level of
general ledger review. (Refer to the Supervisory Committee
chapter.)
Board, The board of directors has the ultimate decision-making authority. It

Committees, approves policies that direct daily operational management and
Operational delegate to staff the authority necessary to fblfill their job
Management responsibilities. (Appendix 4A to the Internal Controls chapter
contains a list of management conflicting positions.) The board of
directors and management have fiduciary responsibility to the
members to maintain high standards of professional conduct.
Evaluating the quality and the effectiveness of management is an

important part of the total analysis process and a major examination
objective. Examiners evaluate the quality of management by
determining the effectiveness of the board of directors, the committees,
and operational management. To evaluate board and committee
Page 7-4
MANAGEMENT
effectiveness, examiners can review various documentation including

board and committee minutes, the credit union’s policies, the strategic
and business plans, management due diligence, and financial and
operational results.
Red Flags Examiners should be aware of any “red flags” which may indicate that
the examiner needs to expand analysis and review of the applicable
operations. Red flags as they relate to management may include the
following:
Overly dominant manager;

Manager or key employee involvement in gambling;
Manager or key employee not taking regular vacations or always
working late hours;
Nepotism on part of the directors or management;
Other forms of insider abuse or preferential treatment;
Limited personnel not conducive to segregation of duties;
Lack of adequate segregation of duties when the credit union has
adequate staffing to achieve such;
Failure to provide, or delays in providing, standard reports, records,
and documents;
Records maintained at home and not in credit union’s control;
Management or staff provide copies of documents rather than
originals;
Inactive supervisory committee;
Lack of, unacceptable, or non-independent audit or verification;
Inadequate internal controls and information systems (IS) controls;
No internal review of override of non-financial reports;
Bank account frequently overdrawn;
Large amounts of cash in transit;
High volume of excessive transactions;
Use of borrowed funds in spite of large cash balances;
Lack of a fraud policy;
Extravagant management or employee lifestyle relative to salary;
Low return on assets or on various asset categories; andor
Payment of above market dividends to attract deposits.
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EXAMINER’S GUIDE
Board The board of directors has the following four basic responsibilities:
ResponsibiIity
0 Select qualified management and evaluate management’s
performance;
0 Establish, regularly review, and revise as necessary business goals,
standards, policies, and procedures;
0 Review operating results and performance of new and existing
activities; and
0 Ensure compliance with applicable laws and regulations, and the
credit union’s own policies and procedures.
While fulfilling these responsibilities, board members should:
Operate independently from management;

0 Attend board meetings regularly;
0 Avoid conflicts of interest and self-serving practices; and
0 Ensure the credit union serves the credit and savings needs of its
field of membership.
The board of directors and management should comply with all

applicable laws and regulations. The board should consider obtaining
an attorney’s opinion on compliance when implementing new services
or products. In addition, the board of directors and management must
comply with laws and regulations that promote equal opportunity for
all members regardless of race, color, religion, gender, national origin,
age, or handicap.
Management must not use the credit union for private gain. They
should restrict use of credit union property to authorized activities.
Management must act impartially and not give preferential treatment to
any individual.
Federal credit unions may not have fewer than five or more than 15
board members. A quorum for board meetings is the majority number
(50 percent plus one) of directors that a credit union’s bylaws
prescribe, even if the credit union has not yet elected the prescribed
number.
Page 7-6
MANAGEMENT
Board and Minutes of board and committee meetings are a primary source of
Committee information by which examiners evaluate a board and its actions. The
Minutes minutes should support conclusions reached by the officials in the
meeting. Analysis of the minutes should enable the examiner to
evaluate how the officials and management interact and perform their
job responsibilities. This information can help determine the adequacy
of management and the effectiveness of the policies. Examiners may
use the AIRES Board Minutes document to record information during
the review of board and committee meeting minutes. By reviewing the
minutes, examiners should be able to determine the following:
0 Adequacy of management’s reports to the board. Thorough and

accurate minutes should cover all aspects of the credit union’s
operations and should document significant changes to capital,
financial performance results, and major credit union activities.
Likewise, the minutes should document supervisory committee
reports presented to the board.
A board’s excessive reliance on benchmark financial statistics

rather than on comprehensive financial analysis suggests that the
directors may fall short in their oversight of the credit union’s
affairs. Undue reliance on only a few indicators may result in
erroneous conclusions about the credit union’s condition.
Examiners should determine that reports to directors support
complete, understandable, and accurate information appropriate to
the size and complexity of the credit union.
The minutes should also include significant actions such as the

following (list is not all-inclusive):
Delegations to management;
Loan policy changes;
Increase or decrease to allowance accounts;
Agreements on collection problem loans;
Loan rate changes;
Recordkeeping problems;
Dividend declarations;
Consideration of new programs;
Investment activities;
Capital accumulation and maintenance policies;
Page 7-7
EXAMINER’S GUIDE
Approval of charged-off loans;

ALM and budget review;
Financial statement review;
Material fixed asset purchases;
Loans to officials;
Progress in meeting goals;
Review of audit reports; and
Compliance with CUMAA requirements.
Oversight of management. Minutes should reflect the board’s

discussion and approval of major strategic or operating decisions,
degree of management’s due diligence, and adoption of major
operating policies and procedures. Management should obtain
board approval before implementing new policies, offering a new
service, or engaging in new activities.
0 Attendance and participation. Minutes should evidence attendance

by board members. Article VI, Section 8 of the FCU Bylaws states
that if a director fails to attend regular board meetings for three
consecutive months, or four meetings within a calendar year, or
otherwise fails to perform the duties of a director, the board may
declare the office vacant and may fill the vacancy in accordance
with the Bylaws. Minutes should identify board members who ask
important questions or make motions to indicate they actively
participate in the meetings.
0 Performance evaluations. Minutes should reflect the board’s

election of officers, its review of management’s performance, and
its deliberations regarding salaries and compensation for officers
and fees for attorneys, appraisers, internal and external
accountants, etc.
0 Compliance with board directives. Credit unions should have

internal systems to monitor operations and ensure that management
takes appropriate actions that conform to board approved policies
and directives.
If examiners find missing or incomplete minutes, they should advise

the board that minutes comprise vital corporate records that document
all board actions.
Page 7-8
MANAGEMENT
Annual The credit union must hold an annual membership meeting, election,
Meeting and a reorganizational meeting of the board in accordance with the
§llO,§lll,and ~112oftheFCUActandArticlesIVandVofthe
FCU Bylaws. Credit unions must adhere to the requirements contained
in the specified sections of the Act and Bylaws. Additionally, credit
unions should follow Robert’s Rules of Order to ensure the annual
meeting meets the standards of a properly run business meeting. The
examiner should review the minutes of these meetings.
Board The board must appoint a supervisory committee composed of not less
Appointment than three, nor more than five, members who are independent of
management and free from any relationship that would interfere with
the exercise of independent judgment as a committee member. The
supervisory committee’s responsibilities include performing or causing
to be performed the annual audit of the credit union and the biennial
verification of member accounts. As such, the supervisory committee’s
independence from the board, management, and operating personnel is
vital. (Refer to the Supervisory Committee chapter for more
information.)
In credit unions that do not have an elected credit committee, the board
may appoint a credit committee, which in turn, can appoint loan
officers. The board appoints loan officers in credit unions that have no
credit committee (see Article VI, Section 6 of the FCUByluws).
The board may also appoint a membership officer, if the board does
not choose to act on membership applications themselves. The board
should also appoint a security officer.
Depending on the size and complexity of the credit union’s operation,

the board may also hire an internal auditor (or in the case of a large
credit union, an internal audit staff), who monitors and reports on the
credit union’s operations for compliance with applicable laws and
regulations as well as credit union policies and procedures. Ensuring
that the credit union has adopted adequate internal controls and that the
officials, management, and staff adhere to these controls also falls
within the purview of the internal auditor.
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EXAMINER’S GUIDE
Operating The board’s most important responsibility involves selecting a capable,

Management competent, and trustworthy manager or chief executive officer (CEO)
for the credit union. Officials should define the CEO’s duties and
responsibilities in writing and then give the CEO the latitude needed to
run day-to-day operations.
Ensuring continuity of operations requires an adequate management

succession plan. A succession plan helps ensure continuity of the
credit union’s operation in the event the CEO or another key manager
can no longer carry out the duties assigned. Adequacy of a succession
plan depends largely upon the size and sophistication of the credit
union. Credit unions need succession plans for not only the CEO, but
also for other key personnel. An integral part of management
succession plans involves cross training of both management and staff
to ensure necessary backup for vacant positions.
Management contracts should not contain provisions that may cause

hardship to the credit union (e.g., salary increases tied to asset growth,
salary not commensurate with asset size, unreasonably long contracts,
golden parachutes, and unreasonable termination provisions.) The
board must implement and adhere to performance standards for the
CEO and senior management and should provide written evaluations
of performance at least annually.
Policies and The board adopts policies to direct the credit union’s activities.
Procedures Procedures represent the methods by which the credit union
implements the policies. Operating policies and procedures establish
management’s strategy for realizing the credit union’s goals, and they
provide a basis for gauging performance.
The board must provide a clear framework within which the CEO can
operate and administer the credit union’s affairs. This includes setting
forth the credit union’s business strategy in the business plan,
investment and loan policies, capital planning, funds management, and
risk management. The board must approve all major policies. Further,
it should review and, if necessary, update those policies at least
annually.
Board policies and procedures should meet the following parameters:
Page 7-10
MANAGEMENT
0 Exist for all major phases of the credit union’s operations;

Establish and provide guidance and direction for a credit union’s
operations;
0 Suffice for the credit union’s operations and risk profile; and
0 Provide guidance and promote controlled and efficient operating
practices.
Board The board of directors must ensure that operating management has
Oversight of procedures in place to implement board-adopted policies. If applicable
Operating to the size, complexity and operation of the credit union, operating
Management management’s responsibilities include the following functions:
Implementing the board’s policies;
0 Providing periodic reports and analysis to the board concerning

policy compliance, such as interest rate risk (IRR) exposure
reports, earnings projections, and capital projections;
0 Reviewing the board’s policies periodically and, when appropriate,

suggesting changes;
0 Managing the operations and staff to achieve the goals and

objectives set forth by the board;
0 Establishing operational procedures;
0 Supervising investment portfolio management activities, including

investing excess liquid funds in instruments that complement the
credit union’s overall riskheturn profile;
0 Maintaining an awareness of the economic and interest rate

environment, particularly local economic conditions, prepayment
trends, volatility, and related regulatory developments;
0 Reviewing asset quality, including trends in delinquencies, non-

accrual loans, real estate owned, charge offs, and recoveries. Also
reviewing the adequacy of reserves and quantifying the effect of
non-performing assets on the riskheturn profile;
Page 7-11
EXAMINER’S GUIDE
Developing, reviewing, and monitoring capital, business, and

strategic plans, and ensuring integration of these plans into the
budgeting function. Also, generating variance, rate, and volume
analysis reports;
Providing adequate support, planning, and oversight when the

credit union enters new business ventures, CUSOs, or new
products and services. Performing due diligence, including cost-
benefit analyses of new products and services throughout the
planning stages. Ensuring that product development activity and
pricing coincide with the credit union’s overall riskheturn profile.
Setting specific standards concerning risks and assumptions;
Managing capital market activities, debt issuance, dividend

policies, and merger and acquisition analysis within the credit
union’s overall riskheturn profile; and
Ensuring that the credit union’s services, products and pricing

support its overall riskheturn objectives. Periodically performing
due diligence, including cost-benefit studies of credit union’s
services, business ventures, and products and comparing the credit
union’s pricing to that of its competitors.
RisWReturn The board and management must realize that the credit union can
Tradeoff generate higher returns in any given economic environment only if it
takes on greater risk; this is the riskheturn tradeoff. The choice
between these two alternatives relates to the management of all the
credit union’s financial functions. The board should analyze riskheturn
tradeoffs in both its planning and decision-making processes.
Examiners should not criticize management for merely taking risks.

Rather, the examiner’s role is to evaluate management’s ability to
identie, measure, control, and monitor the risk.
Financial At the direction of the board and in conformance with the credit
Management union’s goals and strategic plan, management should develop, and the
board should approve, financial and operational policies appropriate to
the size and complexity of the credit union, including:
Page 7-12
MANAGEMENT
0 An annual operating budget supported by specific written

assumptions and a pro forma balance sheet;
An investment policy complying with Part 703 of the NCUA Rules

and Regulations (see the Investment chapter);
0 Written lending and collection policies that comply with NCUA's

Rules and Regulations, Federal Reserve Board regulations, and
other applicable federal and state laws (see the Loans chapter);
0 An ALM policy providing for adequate profitability, cash flow and

monitoring (see the Asset-Liability Management and Liquidity
chapters);
0 Periodic cost-benefit analysis on major services including CUSO

and branch operations;
0 A growth policy consistent with the credit union's net worth needs
and potential risks; and
0 Procedures to address material risk presented by off-balance sheet

items (e.g., letters of credit, bonds borrowing, CUSOs, any
contingent liabilities).
The directors must review and give final approval to the policies and
budget developed by management. Realistic policies and budget
should contain adequate controls to safeguard the credit union's assets,
and should correlate with the strategic plan. Examiners should review
expenses, including salary increases and dividend payouts, in a credit
union experiencing unstable or declining levels of capital or earnings.
Personnel The examiner should determine that the board has approved the
Management following, as appropriate for the credit union's size and complexity:
Written personnel policies that address (& include a training

program) among other things, sexual harassment, violence in the
workplace, and dealing with the media;
Page 7-13
EXAMINER’S GUIDE
Written, detailed position descriptions and performance standards

for all employees including top management;
Carehlly planned recruiting and screening of new employees;
Appropriate training for credit union management and staff;
Salary administration;
Annual written performance evaluations of all employees,

including top management;
Internal controls for all key areas of operation including

information systems, segregation of duties, audit program,
recordkeeping, liquidity contingency plans, and disaster recovery;
Written procedural manuals for all areas of operation;
Provisions for communication;
A fraud policy that includes appropriately filing necessary SAR

forms;
A management succession plan that addresses the steps necessary

for finding a new manager or president for the credit union should
termination, retirement, or resignation of the current
managedpresident occur; and
An on-going concern plan that addresses possible alternatives that

management will implement if the sponsor ceased or significantly
reduced operations. Such a plan is especially critical in one-
sponsor credit unions. Examiners should encourage management of
one-sponsor groups to develop written contingency plans that
include consideration of changing the credit union’s charter to
allow for expansion and diversification.
Service to Management’s efforts to educate the membership play a key role in the
Members credit union’s ongoing success. Educational materials discussing the
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MANAGEMENT
history, philosophy, and uniqueness of the credit union industry may

foster participation and loyalty by current and potential members.
The goals of credit unions are diverse. They include:
0 Meeting the financial service needs of members;

0 Providing access to low-cost lending programs; and
0 Providing secure savings accounts.
Management must recognize demographic changes and the effect these

changes have on the services needed to keep the credit union
competitive. When reviewing service to members, examiners should
consider the following areas:
0 Loan to share ratio. Examiners should look closely at credit unions

with low loan to share ratios (particularly where safety and
soundness concerns are associated with low loan to share ratios) to
determine management’s efforts to promote and generate loan
demand.
0 Market penetration. The f’uture success of the credit union largely

depends on management’s efforts to promote membership and
services to all potential members.
0 Rate structure. A credit union’s future success also largely depends

upon the board setting and maintaining competitive rates.
0 Management due diligence. This includes cost-benefit analyses of

new, existing, and planned products and services, including branch
operations and CUSO activities. The cost-benefit studies should
include whether an equitable assessment of fees to members for the
various services exists.
Planning To anticipate and address rapid changes that may affect a credit
union’s operation, effective management requires dynamic planning
that encompasses the officials’ and management’s shared perception of
f’uture actions.
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EXAMINER’S GUIDE
Planning, which requires a structure and a process, falls within two

classifications: strategic and operational. Strategic planning focuses on
the long-term, extensive allocation of resources to achieve the credit
union’s goals and objectives. Operational planning (e.g., business plan)
concentrates on shorter-term actions designed to implement the
strategies outlined in the strategic plan. The operational plans flow
logically from the strategic plan.
The credit union should carefully monitor and document the planning
function, and periodically revise projections as circumstances change.
Examiners should watch for deviations in strategic or operational plans
that may potentially harm the credit union (e.g., excessive use of
brokered funds; initiating higher risk lending or investment programs
without proper planning, experience, or controls; failure to investigate
and document extensions of credit; and willingness to forgo long-term
stability for short-term profits.)
Following are some key elements of a successful planning process:
Strong commitment from the board and management;

Meaningful engagement in the process from key stakeholders;
Development of measurable goals, including a series of short-term
goals;
Development of strategic objectives;
Clearly defined responsibility, authority, and accountability;
Efficient and effective operational processes;
Necessary managerial, financial, technological, and organizational
resources to achieve goals and objectives;
Policies, internal controls, staffing, training, and management
information systems to support each area of operation and overall
objectives;
Communication of goals, objectives, and detailed business plans
throughout all levels of the organization; and
Periodic reassessment of the progress and effectiveness of the
strategic plan.
Strategic Plan Consistent with the credit union’s size and complexity, the board of
directors should establish a strategic plan that documents
management’s course in assuring that the credit union prospers in the
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MANAGEMENT
next two to three years. At a minimum, this plan should outline the
credit union’s future direction and the optimal capital position relative
to share and asset growth.
The strategic plan encompasses all areas of operations and often sets
broad goals. It enables the credit union to maintain a well thought out
focus, make sound decisions, and may help identify risks or
weaknesses within its operation that an economic downturn may
magnify. An integral part of the strategic plan should include strategic
goals addressing the credit union’s information systems and
technology. This assessment should address the following:
0 Evaluating the types and volume of e-Commerce services the credit

union offers or plans to offer (e-Commerce services include those a
credit union provides, and members access, via electronic means
including, but not limited to, internet and world wide web services,
home banking services, online bill paying services, account
aggregation, and account transaction processing services);
Determining the importance of the e-Commerce systems and

services to the credit union’s operation (e.g., website systems,
home banking or PC based systems, audio response or telephone
based systems, wireless systems, and kiosk); and
Determining proper levels of monitoring and oversight of the

information systems area, given the size and complexity of the
credit union.
Examiners should review the credit union’s planning function and

goals as they relate to the credit union’s risk profile and operation,
including its policies, procedures, and budget. They should also review
the goals that address the information system as it exists and as the
credit union plans for changes in its products and services.
Business Plan Consistent with the credit union’s size and sophistication, management
should establish a business plan for the next one to two years that
implements the strategies outlined in the strategic planning process.
Smaller credit unions with a simple balance sheet may have a short,
concise, written business plan, while credit unions with more
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EXAMINER’S GUIDE
sophisticated operations should have an extensive and detailed

business plan.
Before approving the business plan, the board should ensure its
consistency with the strategic plan. Likewise, examiners should review
the business plan in relation to the strategic plan to determine their
consistency.
The business plan should incorporate the following five steps:
0 An assessment of the environment in which the credit union will

operate over the medium term. The credit union should evaluate its
risk profile and the external and internal factors influencing its
business, including (1) economic and regulatory issues, (2) its
membership base, (3) its competition, and (4) its competitive
opportunities. The credit union should plan for different scenarios
such as high and low interest rate environments, full employment,
and layoffs.
Essential to this assessment is the credit union’s charter type,

which will fall within one of the following (see 5 109 of the FCU
Act and IRPS 99-1 for further details of available charters):
- Single common-bond - one group that has a common bond of

occupation or association;
- Multiple common-bond - more than one group, each of which
has a common bond of occupation or association; or
- Community - persons or organizations within a well-defined,
local community, neighborhood, or rural district.
From this assessment, officials define measurable key objectives

and the acceptable level of risk that management is willing to
assume in attaining the goals. Management documents the plan’s
assumptions and ensures consistency of the budget, policies,
procedures, and resources with the plan’s objectives. The examiner
should determine that management knows of the different types of
charters, and should assess management’s effectiveness in
developing and implementing the business plan and achieving
established objectives.
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MANAGEMENT
0 A clear, written statement of key objectives. These objectives

should have the following characteristics:
- Consistency with the strategic plan, addressing the results of

the credit union’s analysis of external and internal factors;
- Measurability, including details of the mechanism the credit

union will use to measure progress against the established
objectives; and
- Expression in terms of income and expense paths, projected

balance sheets, and other performance indicators, accompanied
by a clear statement of the acceptable level of risk that the
credit union assumes in achieving the plan and the need for
sufficient capital to support any risk-taking.
Consistency with federal and state laws and NCUA regulations.
Communication of the plan’s objectives to management and staff

to assure adherence to both the business plan and strategic goals.
0 Implementation of the plan. The credit union’s policies,

procedures, and resources (employees, capital, equipment,
marketing, and member relations) must support achieving the
business plan’s objectives. Financial performance provides a strong
indicator of the credit union’s viability. Therefore, the credit
union’s performance in achieving its plans influences the
management rating.
Examiners should evaluate the business plan in light of the strategic

plan to determine consistency of the plans. They should also assess
whether the credit union has implemented the plan and whether the
plan operates as the board intends.
Net Worth The board must prioritize maintaining an adequate level of capital for
Restoration the credit union. Prompt corrective action may require development of
Plan a net worth restoration plan (NWRP) when a credit union becomes less
than adequately capitalized. A NWRP addresses the same basic issues
as does the business plan. The board must consider the credit union’s
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EXAMINER'S GUIDE
size, complexity of operations, and field of membership when

developing its NWRP. The board should specify in the NWRP the
steps the credit union will take to become and remain adequately
capitalized. If the credit union requires a NWRP, the examiner will
review the credit union's progress toward achieving the goals set forth
in the plan. (See the Prompt Corrective Action chapter).
Material As part of determining the safety and soundness of the credit union,
Contracts examiners may review all material contracts entered into by the credit
union during the examination period. The extent of analysis will
depend on the effect on the credit union of the contracts, either
singularly or collectively. Examiners should assess the credit union's
ability to fulfill the terms of long-term contracts. Examples of material
contracts can include management contracts, agreements with an
information processing servicer, or long-term leases on land, building,
or equipment.
The examiner must understand that management agreements are

confidential documents. Examiners will not disclose the terms of such
agreements to anyone outside NCUA, and will disclose management
agreement terms to persons within the Agency only when necessary to
promote the safety and soundness of the credit union's operation.
Examiners should discuss questions concerning legality with the

officials, the supervisory examiner, or the regional office, as
appropriate. Examiners should send unresolved legal questions to the
regional office, accompanied by a copy of the contract.
Executive Appropriate compensation policies and practices for management and

staff include defining and implementing performance standards, and
providing written annual performance evaluations prior to salary
adjustments. The compensated director, senior management personnel,
and staff should receive reasonable compensation commensurate with
their duties and responsibilities. Compensation includes any payment
of money or other items of value in consideration of employment
including the following:
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Base salary;
Commissions;
Bonuses;
Pension and profit sharing plans;
Severance payments;
Retirement;
Director or committee fees;
Automobile; or
Fringe benefits.
The FCU Act 0 112 only permits compensation for one elected official.
Credit unions must specifically name this position (often the Treasurer
or Chief Financial Officer) in the Bylaws. Other elected official
positions are volunteers. Even though the credit union may not pay its
directors (except for one), it may provide or reimburse them for items
such as the following:
Mileage;
Insurance (including reasonable life, health, and accident
insurance); and
Travel expenses.
Officials should understand their fiduciary responsibilities when

establishing reimbursements, fees, and benefits for themselves. Each
director should understand the importance of their responsibility for
establishing policies that protect the assets of the credit union.
Credit unions can enter into employment contracts with officers and
other employees with the specific approval of the board of directors;
however, credit unions may not enter into contracts that constitute an
unsafe or unsound practice. Unsafe or unsound practices could lead to
a material financial loss or damage.
Examiners review compensation expenses for reasonableness,just as

they do other credit union expenses. Examiners usually defer to the
board’s decision concerning executive compensation arrangements.
However, if a troubled condition exists in the credit union or it
experiences earnings problems that could present significant safety or
soundness concerns leading to material financial loss or damage to the
credit union, the examiner should address the problem.
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EXAMINER'S GUIDE
Examiners should consider all of the CAMEL components in their

review of employment contracts and other compensation
arrangements. Examiners should ensure that the board annually
reviews all employment contracts and compensation arrangements for
senior management personnel. Board minutes should document
justification and approval of these reviews. Likewise, renewal or
extension of employment contracts requires board approval. Any
director who has a personal interest in the compensation arrangements
should not participate in the deliberations or vote on the arrangements.
Unsafe and While examiners generally should not require changes to

Unsound compensation arrangements in healthy credit unions, they should note,
when appropriate, unsafe and unsound compensation practices. The
Practices
examples below (not all-inclusive) provide illustrations that may
constitute unsafe or unsound compensation provisions:
Compensation arrangements that provide incentives contrary to the

safe and sound operation of the credit union. For example,
compensation based primarily on short-term operating results may
encourage unreasonable risk-taking to achieve short-term profits.
The board should closely monitor compensation tied to current
operating results;
Compensation arrangements that significantly exceed

compensation paid to persons with similar responsibilities and
duties in other insured credit unions of similar size, in similar
locations, and under similar circumstances, including financial
health and profitability;
Contracts that contain automatic renewals or extensions without

providing for the board's explicit review and approval;
Contracts that provide for an excessive term. Generally, a term

should not exceed three years;
Compensation arrangements that provide for excessive total

compensation paid out upon the departure of an employee,
regardless of the reason (e.g., three times the employee's average
annual compensation for the prior five years.) Credit unions should
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MANAGEMENT
not make any payment when termination is for cause. Total

compensation includes payments for the remaining contract term, if
applicable, as well as any severance payments;
Contracts that do not adequately reflect or define the duties and

responsibilities of the employee;
Compensation programs (including deferred compensation,

retirement, and insurance) not commensurate with the duties of the
employee (e.g., vesting requirements that force an employee to
forfeit previously accrued amounts if they do not serve for a
minimum number of years);
Contracts that the credit union collateralizes or otherwise

guarantees, unless the terms provide that the contract is
unenforceable if the credit union becomes a troubled credit union
or the regional director approves the contract;
Contracts that provide for employer reimbursement of costs that

employees incurred seeking to enforce employment contract terms
in the absence of legal judgment or settlement;
Change in control provisions that provide for immediate vesting,

particularly for credit unions in a troubled condition;
Contracts that require payment upon the voluntary resignation of

the employee; and
Contracts that contain golden parachute provisions, including

provisions such as:
- The credit union makes a payment to a person affiliated with

the credit union and contingent on this person’s resignation; and
- The credit union makes the payment while it is in troubled
condition.
Directors’ Directors must continually remain aware of the credit union’s

Conduct obligation to serve its members. Examiners should recognize self-
serving practices that include the following:
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EXAMINER'S GUIDE
Gratuities to directors to obtain their approval of financing

arrangements;
The unauthorized or inappropriate use of credit union services;
The use of credit union funds by insiders to obtain loans or transact
other business; and
Transactions involving a conflict of interest.
Conflicts of Conflicts of interest (or the appearance of such) can adversely affect a
Interest credit union's profitability and reputation risk and can undermine
member confidence. Officials have a fiduciary duty to avoid advancing
their own personal or business interests, or those of others with whom
they have a personal or business relationship, at the expense of the
credit union. Thus, officials must avoid conflicts of interest of any sort,
or even the appearance of a conflict of interest. They should also avoid
nepotism.
The sale of assets to insiders, including fixed assets, repossessed

assets, OFEOs, and foreclosures, can constitute a conflict of interest
and may carry additional reputation risk to the credit union and a
potential cost to the share insurance fund. The sale of assets to insiders
raises the possibility of negative public perception of such transactions.
Insider sales may appear as sweetheart deals, even if economically
sound. Credit unions must ensure that sales of covered assets occur as
arms-length transactions.
The credit union should have a specific plan for dealing with conflicts
of interest, including implementation of controls for avoiding abuses
and procedures for dealing with policy violations. The examiner
should determine if directors and management comply with the policy
and, if not, comment in the examination report and take appropriate
action on actual or apparent conflicts of interest.
On rare occasions, examiners may request additional information

about related organizations or individuals, in order to properly analyze
the financial situation of a credit union. If they do not receive the
information, the examiners should contact the supervisory examiner
for assistance in working with the regional office. If necessary, the
Office of General Counsel may issue an order of investigation and an
administrative subpoena.
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Use of The board of directors must justify and approve contracts that the
Consultants credit union enters into with third parties. The board may delegate this
responsibility to the CEO. Hiring consultants to perform some
functions does not remove responsibility for decisions regarding credit
union operations from the board and management. The board should
adopt a policy requiring management to obtain bids when contracting
with third parties on behalf of the credit union. A cost-benefit study
may help management determine if performing the job using
consultants would result in more cost efficiency and benefit to the
credit union than performing the job in-house. The board should reach
agreements with the consultants on what output the consultant will
provide and should develop reports that will track that output.
Management must use care in contracting with outside parties that

propose to provide business plans or financial models at no direct cost
to the credit union. These vendors often expect the credit union to
transact business with them on an exclusive basis, and management
may feel an obligation to do so. Contracting with such parties could
lead to proposals or transactions that do not serve the credit union’s
best interest.
Management should guard against excessive reliance on outside

consultants and should remain wary of overly simplistic assumptions.
Credit unions sometimes hire third parties, such as consulting firms,
investment brokers, lawyers, accountants, information systems and
technology specialists, or other professionals to provide services not
usually required in the normal course of business.
Political The board of directors is responsible for authorizing any political

Contributions activity by a credit union.
The Federal Election Commission (FEC) administers, interprets, and

enforces the Federal Election Campaign Act of 1971 (the Act) as
amended (2 USC 943 1 et seq.) The FEC regulations, 11 CFR Part 100
et seq., contain implementing regulations that govern political
contributions of credit unions in connection with any election, whether
federal, state, or local.
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EXAMINER'S GUIDE
The FEC regulations generally prohibit a federal credit union from

making political contributions and expending funds for political
communications. However, an exception may apply when a federal
credit union acts as a collecting agent for a separate segregated fund or
political action committee. The FEC regulations, under 1 1 CFR $ 1 14,
describe the rules and special restrictions for collecting agents. Federal
credit unions that serve as collecting agents must also comply with
reporting requirements imposed by the FEC under 11 CFR 5 102.
Directors should consult legal counsel regarding questionable activities
related to political contributions and loan expenditures on behalf of
any political candidates or committees.
Besides the requirements of the Act and FEC regulations, state and
local political activity laws may also govern credit unions engaged in
such activity.
Examiners should report apparent violations and, when appropriate,

forward them to their supervisor. NCUA may forward the referral to
the FEC for enforcement action.
Credit unions may request an FEC advisory opinion from the:
Federal Election Commission

Office of the General Counsel
999 E Street, N. W.
Washington, D.C. 20463
Other Areas Examiners should include in the review of management:

of Review
Management Official Interlocks. $711 and 5741.209 of NCUA
Rules and Regulations address management official interlocks.
These sections generally prohibit a credit union management
official from serving two nonaffiliated depository organizations in
situations where the management interlock would likely have an
anticompetitive effect.
0 Indemnification Payments. A credit union may indemnifjr its

directors, officers, and current and former employees (see
$701.33(c)) for liabilities or legal expenses when the director,
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MANAGEMENT
officer or employee is subject to an enforcement proceeding as a

result of their official duties.
A credit union that elects to provide indemnification must specify

whether it will follow applicable state law or the relevant
provisions of the Model Business Corporation Act. Indemnification
and the method of indemnification may be provided for by charter
or bylaw amendment (must be approved by NCUA), contract, or
board resolution, whichever state law or the Model Business
Corporation Act permits.
The rule permits credit unions to buy commercial insurance on

behalf of its officials and employees to cover liabilities and
expenses resulting from performance of their official duties if
applicable state law or the Model Business Corporation Act
permits such insurance.
Internal The FCU Act gives the board responsibility for the general direction
Controls and control of the credit union. This responsibility includes the proper
and profitable conduct of credit union operations, the safety of credit
union assets, and the accuracy and adequacy of financial statements.
Since the directors do not normally perform the work resulting from
these responsibilities, the employees normally act for them. Thus, it is
crucial that the board establish internal controls sufficient to ensure
that management and staff carry out the organizational plans and
operating procedures according to the board’s expectations.
Sound internal controls mitigate the credit union’s risks by enhancing

the safeguards against system malfunctions, fraud, and errors in
judgment. Although a credit union’s controls often receive careful
review and evaluation, they remain an area of major concern. Without
proper controls in place, management cannot identify and track its
exposure to risk. Controls also enable management to ensure that staff
operates within the parameters established by the board and senior
management.
The following aspects of internal controls deserve special attention

(see the Internal Controls chapter for additional information):
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EXAMINER’S GUIDE
0 Information systems. Credit unions need information systems that

can quickly and efficiently sort and assemble information.
Effective controls will ensure the integrity, security, and privacy of
information contained on the credit union’s computer systems. A
tested contingency plan provides protection in the event of a failure
of the credit union’s information system.
0 Segregation of duties. Ideally, credit unions have adequate

segregation of duties and professional resources in every area of
operation; however, the number of employees in smaller credit
unions may limit this control.
Audit program. Examiners should review the credit union’s audit

program to determine the credit union’s compliance with board
policy. A sound audit function and process requires independence,
with the auditors reporting to the Supervisory Committee without
conflict or interference from management. An effective annual
audit plan ensures examination of all risk areas, with those of the
greatest risk receiving priority. The auditors (both internal and
external) normally issue their reports to management for comment
and action, then forward the reports to the board with
management’s response. The auditors follow up on unresolved
issues (e.g., examination exceptions) and cover these issues in
subsequent reports. The Supervisory Committee’s responsibilities
also include performing a verification of members’ accounts at
least once every two years.
0 Recordkeeping. Credit unions with assets of $10 million or greater

must file their call reports in accordance with generally accepted
accounting principles (GAAP), which means most will keep their
books and records consistent with GAAP. The records and
accounts should reflect the credit union’s current financial
condition and results of operations, and provide an audit trail
containing sufficient documentation to follow a transaction from
its inception through its completion. The credit union’s subsidiary
records should balance with the general ledger control accounts.
0 Protection of physical assets. Safeguarding assets requires limiting

access to those assets to authorized personnel. Credit unions can
protect assets by developing and implementing operating policies
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MANAGEMENT
and procedures for cash control, joint custody (dual control), teller
operations, and physical security of equipment.
0 Staff education and training programs. Credit unions should

implement training programs for staff in specific daily operations,
as well as in credit union industry philosophy. Credit union
training programs should meet management's needs and cross-train
staff.
Succession planning. The ability to fill key management positions

in the event of resignation or retirement could affect the credit
union's ongoing success. A detailed succession plan that provides
for trained management personnel to step in at a moment's notice
enhances the credit union's long-term stability. A succession plan
should address the CEO and other senior management positions.
Fidelity Bond Credit unions must maintain adequate fidelity bond and directors' and
and General officers' insurance coverage. Management is responsible for assessing
Insurance the credit union's insurance and bonding needs; however, the board
must formally approve the coverage, including any riders or
endorsements. The board should evaluate the adequacy of the credit
union's insurance coverage at least annually. In determining insurance
and bond requirements, the board should consider items including the
following:
0 The size of the credit union's asset portfolio and share base;
0 The effectiveness of the internal controls;
0 The amount of cash, securities, and other property that the credit
union normally holds;
0 The number of employees, their experience level, levels of
authority, and turnover rate;
0 The reliability and security of the information system (IS); and
0 The types of services offered.
If the credit union's office is located on the sponsor's property, the

sponsor's insurance policies may cover risks related to property and
liability. However, management should maintain written evidence of
current insurance coverage, including the types of insurance, the
benefits provided, and the limits on coverage. The credit union may
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EXAMINER’S GUIDE
need to supplement existing insurance. If the credit union has relocated

since the last contact, the examiner should determine that the credit
union identified and properly insured any new risks.
Bond coverage provides protection against loss resulting from

employee or director dishonesty or lack of faithful performance.
Generally, a bond covers losses from burglary, robbery, larceny, theft,
mysterious disappearance, forgery, counterfeit money, and other perils.
Various optional endorsements to the bond include directors’ and
officer’sliability, audit expenses, safe deposit box, consumer
legislation, plastic cards, ATM, EFT, ACH, IRA, errors and omissions,
and officer and staff coverage. (For additional surety bond information,
refer to the Bond Coverage chapter in this Guide.) Safety and
soundness concerns may arise if a credit union with minimal reserves
or high exposure to risk lowers its bond coverage in efforts to reduce
expenses.
Listed below are the most common types of insurance coverage (often
included in the credit union’s “package of protection”) that a credit
union might need:
Property and Related - coverage protects against physical loss to

buildings, business property, information processing equipment,
mechanical equipment, etc.;
0 Financial - coverage for financial records (destruction), real estate

errors and omissions, single interest-financed property, chattel lien
non-filing, etc.;
0 Liability - coverage for bodily injury and property liability

exposures of the credit union arising from the use of the premises,
building, or business activities;
0 Worker‘s Compensation - coverage, if required by state law, to

indemnify employees who are injured or killed in the course of
their employment;
0 Group Accident - coverage for qualified employees and credit

union officials, which pays a specific sum in case of death,
dismemberment, or permanent disability;
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MANAGEMENT
Insurance for Members - coverage includes various group or

individual programs such as loan protection, life savings, credit
disability, and accidental death and dismemberment;
0 Employee Benefits - coverage provided for employees such as

group life, health, and retirement. Appropriate fidelity bond
coverage for pension and retirement programs administered by the
credit union should exist; and
Fiduciary Liability - coverage required if the credit union acts as a

fiduciary in connection with an ERISA-covered plan when
providing pension and deferred compensation plans for their
compensated employees and officers (§701.19(b)).
The examiner should determine if management meets its

responsibilities by reviewing the board minutes and insurance policies.
Examiners should discuss any insurance inadequacies with the
officials. The examiner should comment in the examination report on
the absence of prudent risk management by the officials.
Examiners should inquire about any self-insurance programs that the

credit union offers its employees or members. Generally, NCUA
considers self-insurance programs impermissible, unsafe, and unsound.
However, federal credit unions may enact partially self-fimded
employee benefit health plans if the plans meet certain conditions. The
examiner should follow the provisions of NCUA Instruction No.
4062.1 (May 30, 1996) and, after obtaining regional concurrence,
consult with NCUA’s Office of General Counsel for further guidance.
Credit unions frequently buy life insurance policies for the benefit of
employees. Credit unions may also obtain key-person protection. If the
beneficiary of the policy is the employee, the credit union will treat the
cost of the coverage as compensation. The board should annually
review and approve the policy for reasonableness.
NCUA has long prohibited federal credit unions from entering into the
business of insurance on several grounds. First, the FCU Act does not
grant federal credit unions express insurance powers. Second,
insurance powers do not meet the test for a permissible federal credit
union incidental authority. The Office of General Counsel has issued
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EXAMINER’S GUIDE
prior opinion letters restating NCUA’s position on self-insurance (See

OGC Opinion Letters #95-1148, #97-0632, and #99-0447).
FIRREA Any federally insured credit union chartered in the last two years or in
Requiremen&
for New or
-
a troubled condition (CAMEL 4 or 5 ) must give NCUA written notice
of any addition, replacement, reassignment or change in the board of
Troubled
directors, committee members, or senior executive officers. The
Credit Unions
NCUA regional director must receive written notice at least 30 days
before the effective date. NCUA may disapprove the addition,
replacement, or employment of the individual within a 30-day period
(may be extended an additional 30 days) if it finds that the
competence, experience, character, or integrity of the individual would
not serve well the members’ or the public’s interests. Federally
insured, state-chartered credit unions will also file a copy of the notice
with their state supervisory authority.
Credit unions need not give prior notice for new members elected to
the board of directors or credit committee at a meeting of the members.
However, credit unions must file a completed notice within 48 hours
of the election. Federally insured state-chartered credit unions must
also file a copy of the notices with their state supervisor.
The notice should contain, at a minimum, the following information

for each individual:
0 Identity;
0 Personal history;
0 Business background;
0 Experience, including material business activities and affiliations
during the past five years;
0 Any pending legal or administrative proceeding in which the
individual is a party; and
0 Any criminal indictments or convictions of the individual by a state
or federal court.
In addition, the individual on whose behalf the credit union files the
notice must attest to the validity of the information filed and authorize
performance of a credit check.
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MANAGEMENT
After receiving a complete package of information requested, the

regional director has 30 days in which to issue a written notice of
approval or disapproval to each individual and to the credit union. If
the credit union and individual have submitted all requested
information and the regional director has not issued a written decision
within the applicable time period, the regulation specifies that the
individual is approved (§701.14(d)(l).
Incompetent The examiner should never recommend the termination of credit union
or Inefficient management or personnel to the directors. Rather, the examiner should
Management fairly and accurately present findings concerning management's
effectiveness.
When the examiner believes that management's incompetence or

inefficiency has or will have a material effect on the credit union's risk
profile, the examiner should contact the supervisory examiner before
discussing the issue with the credit union. To avoid misunderstandings,
the examiner should consider having a second person present (the
supervisory examiner or another examiner) when discussing sensitive
issues with management.
The examiner should adhere to the following guidelines when

discussing incompetent or ineffective management with a board of
directors:
0 The examiner should document in the file and furnish to the

officials specific facts that support the conclusion of management's
ineffectiveness. Examiners should ensure thorough documentation
exists of conversations with officials regarding management.
0 If material weaknesses in management exist, normally the

examiner and officials jointly develop a plan (Document of
Resolution) to correct these deficiencies. Such action could take
the form of:
- Clearly communicating the board's expectations for the

managing official;
- Conducting periodic performance appraisals;
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EXAMINER’S GUIDE
- Hiring additional management personnel to bolster supervision

in high risk areas;
- Providing outside remedial training for the manager or

official; and
- Seeking remedial assistance from outside sources (e.g.,

leagues, accounting services, etc.)
However, if the corrective action takes the form of replacing

management, this is solelv the decision and responsibility of the
board of directors.
0 If the manager chooses to resign, the credit union should obtain a

written resignation. The board of directors has sole responsible for
deciding whether to accept it.
0 If the board terminates the manager, the examiner should fully

document this action, emphasizing that the decision to terminate
was the board’s and not the result of an order or recommendation of
the examiner.
The officials should consider what effect termination of management

(including the effect of an employment contract) may have on the
credit union. The board of directors should not consent to “hold
harmless” the manager in exchange for the manager’s written
resignation. Such an agreement might impair the credit union’s ability
to recover on a bond claim. The examiner should encourage the board
of directors to consult with their attorney on these issues.
Criticism of management by the examiner does not relieve the credit

union of its contractual and other legal obligations. If the credit union
board does not take steps to deal with management ineffectiveness, the
examiner should consider recommending administrative action (see the
Administrative Actions chapter for additional information.)
and - Management Review
References - Board Minutes
Page 7-34
MANAGEMENT
0 References
$ 110 - Members' meetings
tj 111 - Management; board of directors; credit committee;
supervisory committee; compensation
$ 112 - Executive officers; general manager
$1 13 - Board of directors; meetings; powers and duties;
executive committee; membership officers; membership
applications
$ 114 - Credit committee; meetings; powers and duties;
loans and lines of credit; security
$ 1 15 - Supervisory committee; powers and duties;
suspension of members; passbook
$206 - Termination of insured credit union status; cease-
and-desist orders; removal or suspension from office;
procedure

Article IV - Meetings of Members
Article V - Elections
Article VI - Board of Directors
Article VII - Board Officers, Management Officials and
Executive Committee
Article VIII - Credit Committee or Loan Officers
Article IX - Supervisory Committee

5701.14 - Change in Official or Senior Executive Officer in
Credit Unions that are Newly Chartered of are in Troubled
Condition
$701.21 - Loans to Members and Lines of Credit to
Members
$70 1.33 - Reimbursement, Insurance, and Indemnification
of Officials and Employees
$702 - Prompt Corrective Action
$71 1 and $741.209 - Management Official Interlocks
$747 - Administrative Actions, Adjudicative Hearings,
Rules of Practice and Procedure, and Investigations
Page 7-35
36
7-
Chapter 8
GENERA. L LEDGER
TABLE OF CONTENTS
GENERAL LEDGER ...................................................................................................... 8. 1

Overview .............................................................................................................. 8.2
Expanded Review Procedures.............................................................................. 8-3
Red Flags ................................................................................................. 8-4
Out-of-Balance Conditions ...................................................................... 8.4
Materiality................................................................................................ 8.4
Activity ......................................................................................
. Unusual
. .. 8-5
Examination Period Activity................................................................................ 8.5
NCUA 5300 ............................................................................................. 8-5
Accounts Receivable................................................................................ 8-5
CLF Stock/NCUSIF Deposit ................................................................... 8.6
Prepaid and Deferred Expenses ............................................................... 8-6
Fixed Assets ............................................................................................. 8-6
Capital Leases .......................................................................................... 8-7
Real Estate Sales ...................................................................................... 8-8
Accrual Income ........................................................................................ 8.8
Other Assets ............................................................................................. 8-9
Accounts Payable ..................................................................................... 8-9
Notes Payable........................................................................................... 8-9
..
Dividends Payable.................................................................................... 8-9
Interest Refunds Payable .......................................................................... 8. 10
Taxes Payable .......................................................................................... 8. 10
Accrued Expenses .................................................................................... 8-10
Other Liabilities ....................................................................................... 8-11
Unapplied Data Processing Exceptions ................................................... 8-11
Deferred Credits ....................................................................................... 8. 11
....
Contingent Liabilities............................................................................... 8. 12
Individual Share and Loan Ledgers ......................................................... 8-13
Ledgers Out Of Balance ........................................................................... 8-13
Arbitrary Adjustments.............................................................................. 8. 14
Pension Plans ........................................................................................... 8-15
Accounting for Pension Cost ................................................................... 8. 16
7-
37. 7-3n3-4kA
Chapter 8
GENERAL LEDGER
Examination Evaluate adequacy of policies, practices, procedures, and internal
Objectives controls regarding financial transactions
a Determine that personnel operate in conformance with established
guidelines
a Determine that the credit union properly recognizes and promptly
records assets and liabilities
a Review compliance with the FCU Act, NCUA Rules and
Regulations, and appropriate accounting practices
a Determine accuracy of the Financial and Statistical Reports
(NCUA 5300)
a Assess promptness of corrective action initiated by management
when deficiencies or violations in policies, practices, procedures,
or internal controls regarding financial transactions arise
Associated a Strategic risk. The timely, accurate and consistent recording of

Risks financial transactions affects management’s development and
monitoring of the strategic plan. Deficiencies in financial statement
presentation may lead to ineffective evaluation of new products
and services, and failure to attain financial objectives.
a Transaction risk. Policies and procedures established by the board

and implemented by management should ensure the accuracy and
integrity of data and information. In conjunction with the review of
internal controls, examiners should consider the following items
when evaluating this type of risk:
- The recording of financial transactions in accordance with

appropriate accounting methods;
- The volume and complexity of financial transactions; and
- The expertise and willingness of management to implement
corrections for improving financial reporting.
a Compliance risk. Credit unions must comply with applicable laws

and regulations, including:
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EXAMINER'S GUIDE
- The FCUAct;
- NCUA Rules and Regulations; and
- Regulatory accounting procedures, accounting bulletins, etc.
Additionally, they should be guided by
- The Accounting Manual for Federal Credit Unions (for credit

unions that are less complex); and/or
- Generally accepted accounting principles (GAAP.)
0 Reputation risk. Examiners should consider reputation risk when

developing the Scope Workbook. When evaluating reputation risk,
they should assess whether the credit union:
- Provides current and accurate financial statements and NCUA

5300 reports;
- Implements new accounting procedures and requirements
within acceptable time frames;
- Responds promptly to recordkeeping problems;
- Provides accurate and timely member statements;
- Responds promptly to members' concerns; and
- Performs a thorough analysis of operational needs, staffing,
risk management systems, compliance issues, and long-term
benefits, prior to implementing new products and services.
Overview Examiners should use their professional judgment to tailor the general
ledger review to the complexity of the credit union operation and the
risks present in and around this operation. The review of a credit
union's general ledger and its related subsidiary ledgers should give the
examiner a clear impression of the credit union's financial position and
its relative financial stability.
During the scope development process, examiners should review the

supervisory committee audit report and, if necessary, the workpapers.
Reviewing the prior examination report will assist in determining the
scope of the general ledger review. The scope of the general ledger
review will vary depending upon the following:
Page 8-2
GENERAL LEDGER
0 Reliability of the audit;

0 Concerns noted in previous examination or audit reports;
0 Interviews with management and staff;
0 Extent and quality of management’s due diligence regarding the
credit union’s products, services, and systems;
0 Review of internal audit work, if applicable; and
0 Review of the internal controls of the credit union.
tj741.6(b) of NCUA Rules and Regulations requires credit unions with

assets of $10 million or more to present their NCUA 5300 in
accordance with GAAP. Credit unions with less than $10 million in
assets may present their financial statements using regulatory
accounting principles as set forth in the Accounting Manualfor
Federal Credit Unions.
Expanded The depth of review necessary for each general ledger account will
Review vary within a credit union and from one credit union to another. The
Procedures most critical element for determining the degree of variance and the
necessary depth of review is the examiner’sprofessional judgment,
experience, and risk perception. Examiners can implement the
following additional procedures when warranted:
0 Determine that the general ledger account balances with each

respective subsidiary ledger total;
0 Review the debits and credits and analyze any unusual activity; and
0 Determine the propriety of the entries.
One effective method of reviewing or reconciling general ledger

accounts is to trace entries to source documents or actual receipts.
Except in unusual circumstances, the examiner should not audit or
verify individual entries in either subsidiary ledgers or control
accounts. If material inaccuracies exist in the general ledger accounts,
examiners may support their analyses either by footnoting the credit
union’s financial statements or using the Statement of Financial
Condition and Statement of Income. To avoid distortion of
examination trends and ratios, the examiner prepares adjusting entries
in the General Ledger Journal Adjustments when a material out-of-
balance condition exists between a subsidiary ledger and its general
ledger control account.
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EXAMINER'S GUIDE
Red Flags Some of the red flags in the accounting area that may require
examiners to consider expanding their procedures include the
following:
9 Ongoing recordkeeping problems;

9 Cash and bank reconciliations not complete, in arrears, or with
(fluctuating) out of balance amounts;
9 Excessive teller overages or shortages, either in number or amount;
9 IOU's in teller or vault cash;
9 Numerous erasures, corrections, whiteouts, line-outs;
9 Numerous voided or third party checks;
9 Numerous stale-dated outstanding checks;
9 Numerous stale-dated reconciling items;
9 Lump sum postings not conducive to good audit trail;
9 Checks or transactions receipts missing or out of sequence;
9 Timeliness of deposits not in accordance with Bylaw requirements,
if adopted by the credit union;
9 Bank account activity andor bank account balances (or share draft
clearingdtotal share draft balances) exceeding realistic needs;
9 Excessive number of depository accounts providing potential for
kiting; and
> Excessive cash/assets ratio (indicating poor cash management or
possibly fraud.)
Out-of-Balance The examiner normally does not attempt to balance or audit subsidiary
Conditions ledgers to the control accounts. The examiner should discuss the
concern with management and obtain agreement for corrective action.
(When examiners suspect fraud or embezzlement, they should
immediately contact their supervisory examiners for further guidance.)
Materiality The credit union's size and its ability to absorb potential losses may
significantly affect what examiners consider material. In assessing the
materiality of a general ledger account, the examiner considers its
effect on the credit union's profitability and net worth. In some
instances, the account may have minimal effect on the balance sheet,
while it may have a material effect on the income statement. For
example, overstating accrued income may have little or no effect on
Page 8-4
GENERAL LEDGER
the balance sheet but could mean the difference between a negative
and positive bottom line on the income statement.
Unusual Unusual activities include those the examiner deems improper or

Activity uncommon, or which might adversely affect the credit union. This
review should consider the size and frequency of the transactions.
These accounts may have numerous entries during an accounting
period, but clear out by the end of the period (e.g., ATM, credit cards,
travelers’ checks, money orders, and share draft clearing accounts.) The
examiner may review this activity on a test basis to ensure the
appropriateness of the entries (this may include a sample review of
source documents or receipts.) The review should also satisfy the
examiner that the account entries do not temporarily camouflage other
activities.
Examination Examiners should concentrate the scope of the general ledger review
Period primarily on activity during the examination period. For example, if
Activity the credit union purchased its building in a prior examination period,
and if examiners reviewed the account during the last examination,
current examiners need not perform another complete analysis. Instead,
they may determine the credit union’s current fixed asset position and
the ability of the earning assets to support the non-earning assets.
NCUA 5300 The examiner will review the accuracy of the Financial and Statistical
Reports (NCUA 5300 Call Report) submitted since the last
examination and the credit union’s process for ensuring accuracy of
the 5300s. The review of 5300s often takes place during supervision. If
examiners discover material errors or omissions, they should inform
the officials, provide appropriate instructions to ensure proper
completion in the future, and make corrections according to regional
policy.
Accounts Accounts Receivable generally represent funds due the credit union
Receivable from persons other than members. Receivables may include payroll
deductions, insurance premiums, taxes, etc. If a credit union has
material accounts receivable, the examiner may determine that (1) the
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EXAMINER'S GUIDE
receivables exist, (2) the credit union receives payments on schedule,

and (3) staff reconciles the subsidiary ledgers. Staff should promptly
follow up on receivables that do not clear. Receivables that do not
eventually clear will ultimately result in charges to an expense account
and could affect the financial stability of the credit union.
CLF Stock/ When a credit union is a direct member of the Central Liquidity
NCUSIF Facility (CLF), the examiner may review the CLF stock subscription
Deposit computation. If either an overpayment or an underpayment exists, the
examiner should require the credit union to notify the CLF.
When reviewing the Share Insurance Capitalization Deposit, the

examiner should compare and reconcile the credit union's recorded
deposit to that reported by the periodic statements from the share
insurance fund. Examiners should also review for accuracy uninsured
shares reported on the 5300 Call Report as of December 3 1, since they
affect the capitalization deposit.
Prepaid and Prepaid and Deferred Expenses represent expenses that the credit
Deferred union has paid for, and supplies or services that have remaining value
Expenses to the credit union (i.e., not fully used up.) Common examples include
office supplies, prepaid fidelityhond insurance, and prepaid league
dues. The credit union often pays for these items annually so that at
any point before year-end, some value remains (i.e., an item paid on
January 1 for the full year would have six months' value (and expense)
remaining in June.) These prepaid expenses must have a future value
for a coming period, and not cover a prior period. Unless materiality
factors exist, the examiner usually limits the review to the
reasonableness of the entries in these accounts.
Fixed Assets The credit union may either own or lease (under a capital lease) its
fixed assets. Fixed Assets include three major, and often material,
categories:
0 Land and buildings;

0 Furniture and equipment; and
0 Leasehold improvements.
Page 8-6
GENERAL LEDGER
Before making a major investment in fixed assets, the board of

directors should instruct management to perform due diligence,
including carefilly analyzing the need for the asset, and its expected
effect on the credit union's fbture earnings ability from the standpoint
of both the additional depreciation expense and the lost opportunity
costs of the income. (Credit unions may better serve their members by
providing faster and more convenient services using advanced
computer technology such as home banking than by brick and mortar
expansion.) Income from the earning assets (loans and investments)
should support the investment in fixed assets.
Management should also consider the credit union's reserve position

and ratio of "non-cost" capital (the income retained by the credit union
as Undivided Earnings or reserves, for which the credit union pays
neither interest nor dividends) to non-earning assets. A relatively high
capital level reduces the burden on earning assets.
The credit union may employ various capital budgeting techniques to

determine the payback method, the accounting rate of return, or the
internal rate of return.
Investments in fixed assets require board approval. Management

should purchase fixed assets in compliance with established board
policy. Credit unions should record the purchase price and set up
depreciation schedules in accordance with acceptable accounting
practices.
The examiner may determine that the credit union complies with
9701.36 of the NCUA Rules and Regulations regarding the purchase of
fixed assets. Credit unions eligible for Part 742, Regulatory Flexibility
Program, may be exempt from §701.36(a), §701.36(b), and §701.36(c.)
When reviewing the regulation, the examiner should understand that
while GAAP affords capital leases and operating leases different
accounting treatments, the regulation requires inclusion of both
operating and capital leases in the definition of "investment in fixed
assets."
Capital Leases From the standpoint of the lessee, two major categories of leases exist:
capital and operating. Generally, a capital lease transfers substantially
Page 8-7
EXAMINER'S GUIDE
all of the benefits and risks of ownership of the asset, while operating
leases more closely resemble rental payments.
Real Estate Transactions involving the sale of credit union-owned property often
Sales have complicated accounting treatments with various profit
recognition and disclosure requirements. An examiner encountering
sales of credit union owned real estate should determine the facts and
circumstances of the sale and, if necessary, discuss the situation with
the supervisory examiner.
Accrual Accrued Income is income the credit union has earned but has not yet
Income received. Common examples include accrued interest on loans and
accrued income on investments. Loans and many investments earn
income from the day the credit union establishes the asset. The credit
union may not receive income from these assets for a month (with
loans) or longer (with investments.)
When a credit union adopts accrual accounting between examinations,

the examiner should determine that the accounts were properly
established. Examiners may verify the accruals for accuracy.
Depending on the complexity of the credit union's operations, the
examiner should review and analyze the schedules used in calculating
the accrued income on loans or investments.
If the information system (IS) generates estimated accruals, the

examiner may verify their accuracy through sampling. For example,
some automated accounting systems can generate a detailed list by
account number for the accrued income on loans. The examiner should
also determine that the credit union does not accrue interest on loans
90 days or more delinquent.
If the examiner's estimate differs substantially from the recorded

accrual, the examiner should expand the analysis to determine proper
formulation of, and adherence to, policies and practices for accrual of
interest on delinquent loans. The examiner should also review how the
credit union arrived at its figures. When assessing the materiality of
inaccuracies identified in the accruals, examiners should consider the
Page 8-8
GENERAL LEDGER
effect on reported income. Either an under- or over-statement in the

estimated accrual can materially affect profitability.
Other Assets Other Assets can include deposits with public utilities, insufficient
funds checks, the premium stabilization deposit, monetary control
reserve deposits, escrow accounts on serviced real estate loans, and
assets acquired in liquidation. In general, the examiner may determine
the reasonableness of the balances and dates recorded. The credit union
should charge off the portion of an account representing a
nonrefundable or nonrecoverable amount.
The examiner may verify that the credit union books the value of
assets acquired in liquidation in accordance with acceptable accounting
practices.
Accounts Accounts Payable represent obligations of the credit union including

Payable payroll deductions that the credit union has not yet distributed to share
accounts, remittances due for travelers' checks, insurance premiums
due, etc. The examiner may (1) determine the date of origin, and (2)
review material amounts to ensure the credit union reconciles
subsidiary ledgers with control accounts and makes payments when
due.
Notes Payable Notes Payable are borrowings by the credit union, typically through the
corporate credit union network or other financial institutions. Credit
unions may borrow from any source in an aggregate up to 50 percent
of its paid-in and unimpaired capital and surplus. The board is
responsible for developing a use and repayment plan for borrowed
funds.
Dividends Credit unions use this account only at the end of dividend periods to
Payable reflect the actual or estimated amount of dividends due and payable to
the members. Dividends Payable, while set up at the end of each
dividend period, should normally clear out shortly afterwards. If a
balance remains in the account as of the examination date, the
examiner should explore the reasons and may determine that the
Page 8-9
EXAMINER'S GUIDE
amount ties to a dividend payable report or represents a reasonable

estimation.
Interest Some credit unions use interest refunds as a method of returning part
Refunds of the credit union's profits to the members. Members, who have paid
Payable interest on loans during the period, receive back a portion of the
interest they have paid.
Taxes Payable Taxes Payable depict accounts payable to governments, usually

including Social Security, federal, and state withholding taxes. These
accounts will normally clear out monthly or quarterly. If not, the
examiner may determine whether the credit union uses proper
accounting for these accounts. Although the amounts payable in taxes
usually are immaterial, credit unions can incur substantial fines and
penalties for nonpayment. Since NCUA does not enforce Internal
Revenue Service or state tax regulations, examiners should direct their
concern toward the credit union's prevention of tax problems.
Accrued Accrued Expenses represent expenses that the credit union has
Expenses incurred and which it owes in the current period but will pay in a
future period. These may include compensation, employee benefits
(e.g., vacation and sick leave pay), and office operations. An accrued
expense is an expense for the current or prior period. Credit unions
may not prepay them. As is true of accruing income, accruing expenses
more accurately presents the credit union's financial position.
Accrued expenses include accrued dividends payable. Credit unions

that accrue dividend expenses more frequently than the actual dividend
period should record the liability in Accrued Dividends Payable. Even
credit unions that use the modified cash basis of accounting must
accrue dividends contracted for or specified in advance, such as share
certificates, to comply with the full and fair disclosure requirements of
5702.402 of the Rules and Regulations. The examiner may determine
the reasonableness of the recorded dividend accrual on share accounts
where the credit union specifies or contracts for the dividend rate in
advance.
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GENERAL LEDGER
Other Other Liabilities include liabilities under pension plans, collections on

Liabilities loans and other obligations serviced, obligations under capital leases,
monetary control pass-through deposits, and undisbursed loan
proceeds. Material balances should reconcile to the appropriate
subsidiary ledgers or external statements.
Unapplied The Unapplied Data Processing Exceptions account allows the credit
Data union to reconcile the general ledger control accounts with the
Processing individual share and loan ledgers when the IS rejects entries in the
Exceptions
latter. For example, if staff posted a share withdrawal to both the
journal and cash record and to the individual share ledger but keyed in
an incorrect account number, the share ledger will exceed the journal
and cash record by the amount of the rejected withdrawal. If the credit
union closes its books before making the correction, the general ledger
will not balance with the individual share ledger. Correcting the
exception requires debiting a general ledger suspense account,
Unapplied Data Processing Exceptions, and crediting the general
ledger shares account, thus balancing shares to the share ledger. The
credit union will debit shares and credit the suspense account to correct
the entry.
Complicated transactions can occur in this account when compounded

by payroll deduction errors, input errors on refinanced loans with
temporary disability insurance, corrections to prior period’s dividends,
etc.
An unreconciled suspense account can contribute to a severe record

keeping problem with the potential for material adjustments and
losses. Depending on materiality, the examiner may (1) determine that
the balances reconcile to an appropriate subsidiary ledger, (2) ensure
that reconciling items clear out on a timely basis, and (3) review
frequent or consistent transactions through these accounts for
appropriateness. Whether or not the suspense account has a balance as
of the examination date, the examiner may review the activity in the
account since the last examination.
Deferred Deferred Credits represent income received but not earned. Deferred
Credits Credits includes fees the credit union charges a member for entering
Page 8-11
EXAMINER'S GUIDE
into an agreement to make a loan and direct loan origination costs. If

the member exercises the commitment, the credit union transfers the
net balance to the appropriate loan contra account for net commitment
fees. The credit union may choose whether to follow GAAP or to
amortize the fees over the life of the loan or ten years, whichever is
shorter, as an adjustment of yield using the interest method. Credit
unions on a modified cash basis, or if the amount is immaterial, should
amortize the net fees over the shorter of the life of the loan or ten
years, as an adjustment of yield using the interest method.
Contingent Examiners should discuss with management and, if necessary, fully

Liabilities analyze contingent (unrecorded) liabilities, or "off-balance sheet"
items, to determine the financial effect on the credit union. Examples
include long-term management contracts with employees, long-term
contracts with information processing suppliers, long-term leases for
fixed assets, claims that significantly exceed premiums on a select
risk-rating insurance plan, employee pension plans, accrued sick leave
and vacation, unused lines-of-credits and credit cards, unfunded
construction loan commitments, and pending legal suits.
The reviews of board minutes and audit reports often provide clues to
the existence of contingent liabilities. Asking questions of
management about the degree of credit union involvement in these
activities along with reviewing significant contracts, insurance
policies, and pension plan information aid examiners in analyzing this
area.
When examiners note significant contingent liabilities, they should

determine that the credit union meets full and fair disclosure
requirements. They can determine full and fair disclosure in several
ways, such as the establishment of proper accrual accounts or footnotes
to the financial statements. If the credit union's financial and statistical
reports do not show material contingent liabilities as footnotes,
examiners should reach agreements that management will provide the
footnotes on future reports.
Page 8-12
GENERAL LEDGER
Individual Credit unions use many different accounting systems to track

Share and individual share and loan accounts: hand posted ledger books, ledger
Loan Ledgers cards, in-house computers of various capacities, and outside service
bureaus. Each system differs somewhat from the others. The examiner
should take the time to become familiar with each system and
understand what the data represents. Although the systems have
differences, they share the common purpose of maintaining the
subsidiary ledgers to general ledger control accounts.
Small credit unions often have two subsidiary ledgers, the individual
share and loan ledgers, and two control accounts, the general ledger
share and loan accounts. Larger or more sophisticated credit unions
may have many subsidiaries for both shares and loans, including
separate ledgers for real estate loans, student loans, consumer loans,
regular shares, share drafts, etc. In all cases, subsidiary ledgers must
balance with the control account and the total of subsidiary ledgers for
both shares and loans with their respective general ledger accounts.
Ledgers Out If the trial balance totals of the individual share and loan ledgers do not
Of Balance agree with their respective control accounts in the general ledger, or if
one or more subsidiary ledgers do not agree with their respective
control accounts, the out-of-balance condition could represent varying
degrees of seriousness. These could vary from an innocent error in
extension of balances to an embezzlement of sizeable proportions. The
examiner should verify the reason for material out-of-balance
conditions. The examiner may guide the officials in resolving the
situation.
Regardless of the mechanics required to correct the out-of-balance

condition, the examiner should make it clear to both the treasurer and
the board that the treasurer has responsibility for keeping accurate
books and records current and in balance. Responsibility for locating
and correcting existing errors, determining the reasons for the errors,
correcting the causes, and preventing a recurrence ultimately falls to
the board.
The examiner should not attempt to balance the records or spend

considerable time searching for errors after pinpointing the type of
error that occurred, unless evidence of dishonesty exists. If dishonesty
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EXAMINER'S GUIDE
exists, the examiner should consult with the supervisory examiner

before proceeding with additional test checks. The examiner should
develop specific plans of action with the officials to find errors,
balance the ledgers, and eliminate the causes.
Credit unions must resolve out-of-balance conditions. However, a

difference, which could affect the financial condition of the credit
union, requires more immediate correction than does a difference of a
few dollars made in a recent dividend calculation.
Even though a substantial difference may exist, a stable difference

presents a lesser problem than a difference that fluctuates from period
to period. A stable difference usually occurs in an identifiable, specific
period and does not usually represent a continuing problem with
internal controls and record keeping. It may represent a one time
occurrence.
Arbitrary When any of the credit union's records (General Ledger, Journal and
Adjustments Cash Record, Individual Share and Loan Ledgers, or material
subsidiary ledgers) are in arrears and staff cannot bring them current
during the examination, the examiner should consider delaying the
completion of the examination until staff brings the records current.
This should also hold true if the general ledger is out of balance. When
examiners delay the examination, they should reach agreements with
the officials to correct the problem. Examiners should discuss any
delays in the examination with the supervisory examiner for
concurrence with plans before reaching agreements with officials.
If, upon returning to the credit union, examiners find that the officials
have failed to follow through on agreements reached, they should
complete the examination using the most current meaningful data
available. As appropriate, they will discuss the situation with the
supervisory examiner and come to an agreement on how best to handle
the situation, in accordance with regional policy.
Serious and persistent record keeping deficiencies may warrant

administrative action. Persistent record keeping deficiencies may
constitute serious recordkeeping problems that continue to exist past a
usual and normal period of time. NCUA considers persistent
Page 8-14
GENERAL LEDGER
recordkeeping deficiencies serious if a reasonable doubt exists (1) that

the credit union's financial statements accurately and fairly present the
financial condition of the credit union, or (2) that management
practices and procedures sufficiently safeguard the members' assets. In
addition to administrative actions, NCUA can require the credit union
to obtain an outside, independent audit by a certified public
accountant. (See 97 15 of the NCUA Rules and Regulations and the
Supervisory Committee section of this Guide.)
When the credit union cannot determine available earnings because it

has not prepared an accurate financial statement, it may not declare
dividends until the board of directors can determine if the credit union
can pay a legal dividend.
If examiners do not consider differences material and the differences

have not fluctuated during the previous three months, the examiner
may ask the directors and the supervisory committee to authorize an
arbitrary adjustment for the difference.
Pension Plans The examiner's objective in reviewing pension plans should determine
the following:
0 Subsidiary records exist to document the existence of the pension

plan;
0 Proper methods account for the plan;
0 The financial statements contain the appropriate pension plan
disclosures; and
0 The board of directors has recognized and approved the plan.
A pension plan is a contract between a credit union and its employees

whereby the credit union agrees to pay benefits to employees upon
their retirement. Pension benefits generally consist of monthly
payments and may provide for additional payments when employees
die or become disabled.
A pension plan may be formal or implied by credit union practice. A

credit union, individually or collectively with other credit unions, may
establish a plan. Due to their complexity, credit unions should only
undertake participation in any pension plan with the advice of legal
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EXAMINER’S GUIDE
counsel. If the pension plan involves the placement of pension funds in

trust or custodial accounts in the credit union, the credit union must
comply with the applicable Federal Credit Union Bylaws (if the credit
union has so adopted), and Part 724 of the NCUA Rules and
Regulations. A substantial difference can exist in a credit union’s
obligation between a defined benefit plan and a defined contribution
plan. Additionally, credit unions should ensure and document
compliance with IRS regulations, Pension Benefit Guaranty
Corporation guidelines, and Department of Labor requirements.
Pension plans may be either funded or unfunded. Under a funded plan,

the credit union makes regular periodic payments to an insurance
company or trustee, which agrees to assume the responsibility of
distributing retirement checks to recipients. In an unfunded plan, the
credit union makes periodic payments directly to its retired workers.
The plan may be contributory, where the employees bear part of the
cost, or it may be noncontributory, where the credit union pays the
entire cost.
Accounting for When a credit union adopts a pension plan, actuarial tables determine
Cost the past service cost and the normal cost. Once the credit union
ascertains the costs, it establishes a funding policy. Credit unions
usually fund normal costs and expense those costs the same year they
occur. The funding policy for past service costs also affects the amount
of recorded expenses for any period. However, no requirement exists
that the amount of pension expense related to service costs must equal
the cash put into the fund to finance those costs during any one period.
A particular credit union’s funding and expense policies will result in
one of the following:
0 The amount of recorded pension expense equals the cash paid into
the fund. This situation can only arise when the amortization
period equals the funding period for past service costs. In this
example, no requirement exists to establish an account in the
general ledger for any over- or under-accrual of the liability for
pension costs.
0 The amount of recorded pension expense exceeds the amount paid

into the fund, creating a pension liability. This arises when the
Page 8-16
GENERAL LEDGER
funding period for past (and changes in prior) service costs extends
longer than the expense amortization period.
0 The amount of recorded pension expense is less than the amount

paid into the fund, creating a pension asset. This arises when the
funding period for past (and changes in prior) service costs is
shorter than the expense amortization period.
Due to the complex nature of accounting for pension plans, the credit
union should obtain competent outside assistance, if needed, to fully
comply with GAAP and disclosure requirements. As credit unions
grow larger and employ more staff, credit union pension plans increase
in importance within the expense structure of a credit union. Proper
accounting and the need for full and fair disclosure become
increasingly necessary.
and - Statement of Financial Condition
References - Statement of Income
- Journal Entries Summary
- Financial History
0 References
701.36 - FCU Ownership of Fixed Assets
702.402 - Full and Fair Disclosure
715 - Supervisory Committee
724 - Trustees and Custodians of Pension Plans
725 - Central Liquidity Facility
741.6 - Financial and Statistical and Other Reports
Page 8-17
m7 Ad.&
Chapter 9
CASH ANALYSIS
TABLE OF CONTENTS
CASH ANALYSIS .......................................................................................................... 9. 1

Cash and Cash-Like Items ................................................................................... 9-2
Red Flags ............................................................................................................. 9-3
Expanded Review Procedures.............................................................................. 9-4
Petty Cash Review ............................................................................................... 9-4
Teller Change Fund Review ................................................................................ 9-5
Vault Change Fund Review ................................................................................. 9-8
ATM Change Fund Review ................................................................................. 9-10
Bank Account Review ......................................................................................... 9-11
Credit Bank Account Balance .............................................................................. 9-14
Sweep Accounts ................................................................................................... 9-14
Treasurer's Drafts ................................................................................................ 9-15
Official Check Programs...................................................................................... 9-15
On-Us Share Draft Accounts ............................................................................... 9-15
Money Orders and Travelers Checks ................................................................... 9-16
Other Negotiable Items ........................................................................................ 9-17
Excessive Transactions ........................................................................................ 9-17
Federal Reserve's Payment System Risk Program ............................................... 9-18
Fraud Detection .................................................................................................... 9-19
Alternative Examination Procedures for Small Credit Unions ............................ 9-19
Receipt and Disbursement Test ........................................................................... 9-20
Receipts Test ............................................................................................ 9-20
Disbursements Test .................................................................................. 9-21
Reconciliation of Receipts with Deposits ................................................ 9-21
APPENDIX 9A - Wire Transfers..................................................................................... 9A-1
APPENDIX 9B - Automated Clearing House Network ................................................. . B-
9 1
APPENDIX 9C - Item Processing.................................................................................. . C-
9 1
Chapter 9
CASH ANALYSIS
Examination 0 Determine whether adequate accounting policies, practices,
Objectives procedures, and internal controls exist for all phases of cash
operations
Determine whether the credit union has established guidelines
addressing cash operations within which officials and employees
operate
0 Determine whether adequate security measures and surety bond
coverage exist for cash operations including cash storage,
replenishment, deposit activities, and transportation of cash and
cash-like items
Associated Cash operations have various associated risks. Following are the
Risks primary risks associated with cash analysis:
0 Liquidity risk - the credit union should have sufficient cash to meet
member share and loan demand and pay operating expenses;
0 Transaction risk - the board should adopt, and management should
implement policies and procedures that ensure the accuracy and
integrity of data and information regarding the credit union’s cash
accounts. In conjunction with the review of internal controls,
examiners should consider (1) the proper recording of cash
transactions, and (2) the volume of cash transactions when
evaluating transaction risk;
0 Compliance risk - examiners should ensure the credit union has an
adequate program in place to properly report cash balances and
cash transactions as required by current laws and regulations,
including Regulation D, BSA and OFAC; and
0 Reputation risk - when evaluating reputation risk, examiners
should assess whether the credit union maintains the highest level
of integrity and honesty over cash accounting and transactions.
Page 9-1
EXAMINER’S GUIDE
Cash and The following are cash and cash-like accounts established by the credit
Cash-Like union’s board of directors for specific purposes. The board authorizes
Items the amount for each cash account (petty cash, teller change fund, vault
change fund, ATM change fund and bank cash):
Petty cash - used for making incidental payments and defraying

other immaterial expense items;
0 Teller change fund - used for processing member transactions; may

vary in amount based on temporary, seasonal, and projected
demands;
Vault change fund - replenishes drains on teller change funds; may

vary in amount based on temporary, seasonal, and projected
demands;
ATM change fund - provides cash for proprietary ATMs to process

member ATM transactions; may vary in amount based on
temporary, seasonal, and projected demands. Occasionally, credit
unions assign ATMs “teller numbers” and include the funds in the
teller change fimd general ledger account. If so, each ATM on the
system should have an identifying number to allow for an audit
trail of cash differences by individual ATM;
Bank cash - (1) includes cash in banks, savings banks, savings and
loans, etc.; (2) usually replenishes vault, teller, and ATM change
funds; (3) covers loan disbursements, expense disbursements,
payroll, and share withdrawals; and (4)usually is a non-interest
bearing account or one that earns only a nominal rate. Credit
unions should maintain bank cash at reasonable levels or at
minimum compensating balance requirements to limit fee
assessments;
Money orders, travelers checks, postage, theater/amusement park

tickets - sold by credit unions as a service to the members;
represent negotiable monetary instruments that can easily convert
to cash; not normally recorded in the general ledger or reflected on
the Statement of Financial Condition; and
Page 9-2
CASH ANALYSIS
Other negotiable instruments - rarely encountered negotiable

monetary instruments; warrant review when the examiner
identifies them during the course of an examination.
Red Flags Examiners should watch for the following “red flags”, which can alert
them to diversion or manipulation of cash by management or staff:
0 Accounting/Reconciliations:
Ongoing recordkeeping problems;
Cash and bank reconciliations not completed, in arrears, or
with fluctuating out of balance amounts;
Excessive teller overages or shortages, either in number or
amount;
IOU’s in teller or vault cash;
Numerous erasures, corrections, whiteouts, line-outs;
Numerous voided or third party checks;
Numerous stale dated outstanding checks;
Numerous stale dated reconciling items;
Lump sum postings not conducive to good audit trail;
Checks or transactions receipts missing or out of sequence;
Timeliness of deposits not in accordance with Bylaw
requirements;
Bank account activity and/or bank account balances (or share
draft clearingdtotal share draft balances) exceed realistic needs
on any single day;
Excessive number of depository accounts providing potential
for kiting; and
Excessive cash/assets ratio (indicates either poor cash
management or possibly fraud.)
Management:
9 Overly dominant manager;
9 Manager or key employee involvement in gambling;
9 Regular vacations not taken, always working late hours;
9 Nepotism;
P Other forms of insider abuse or preferential treatment;
9 Limited personnel not conducive to segregation of duties;
P Lack of adequate segregation of duties when the credit union
has adequate staff;
Page 9-3
EXAMINER'S GUIDE
Failure to provide, or delays in providing, standard reports,

records, and/or documents;
Records maintained at home or in inappropriate location;
Management or staff provide copies of documents rather than
originals;
Inactive supervisory committee;
Lack of, unacceptable, or non-independent audit or verification;
Inadequate internal controls and information systems (IS)
controls;
No internal review of overridehon-financial reports;
Bank account frequently overdrawn;
High volume of excessive transactions;
Use of borrowed funds in spite of large cash balances;
Extravagant management or employee lifestyle relative to
salary; and
Lack of a fraud policy.
0 Other:
> Low return on assets or on various asset categories; and
> Payment of above market dividends to attract deposits
Expanded The depth of review necessary for each cash account will vary within a
Review credit union and from one credit union to another. The most critical
Procedures element for determining the degree of variance and the necessary depth
of review is the examiner's professional judgment, experience and risk
perception. Examiners can obtain assistance in assigning the level of
risk by reviewing the appendix to the Risk-Focused Program chapter.
The remainder of this chapter includes additional procedures that the
examiner may implement when warranted.
Petty Cash Although the petty cash fund authorization is generally immaterial, in
Review cases where examiners note problems they may decide to review the
fund to determine that:
0 The balance of this fund does not exceed the authorized amount;
0 Management has physically segregated it from other cash funds
and provides accountability by limiting access;
Page 9-4
CASH ANALYSIS
0 Valid receipts or signed cash vouchers evidence payments from the

hnd, and the sum of the fund, receipts, and vouchers total to the
authorized amount;
0 Management replenishes the fund in a timely manner and records
the proper expense categories at least monthly;
0 Management approves any changes in the fund’s balance; and
0 The supervisory committee or other independent party periodically
verifies the fund.
Teller Change Depending on transaction volume and temporary, seasonal, and

Fund Review projected demands, teller change funds can represent a substantial
portion of cash inventory. Examiners’ scrutiny of teller fund operations
may include a review of the following:
0 Master Log maintained by the head teller or operations manager;
0 At least two days of individual, signed, end-of-day, teller cash

counts including related daily work transaction vouchers. If a teller
is off work on the day of the verification, examiners must obtain
the prior working day’s end-of-day teller cash count and related
transaction vouchers;
0 At least two days of system-generated individual teller summary

transaction activity reports that reflect the system’s beginning and
ending cash balances, check transactions, and cash transactions;
0 Teller change fund general ledger detail; and
0 Log of Bait Money, including denominations, and serial numbers

assigned to each individual teller.
The entries on the Master Log should balance to the individual and
aggregate, end-of-day, teller cash counts. The individual teller cash
counts should balance to the ending cash balance on the system-
generated teller summary reports. The total ending cash balances for
all tellers should balance to the amount of the overall change fund
appropriated to teller change funds in the general ledger.
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EXAMINER’S GUIDE
Individual, end-of-day, teller cash counts should balance with the next
day’s beginning cash on the system-generated teller summary reports.
Some data processing systems allow manual input of beginning cash
balances. This weakness could disguise or postpone recognition of an
out-of-balance condition or shortage. If the credit union cannot modifl
its computer system, management can mitigate concerns about this
weakness by rotating teller drawers among tellers on a surprise basis.
Examiners and auditors routinely perform month-end examinations

and audits; however, examiners do not perform cash counts.
Management or supervisory committee personnel should periodically
perform surprise cash counts.
Examiners should consider the following if they decide to review teller

change funds:
The amount set up in the teller change fund does not exceed the
maximum established by the board of directors, the individual
teller change funds do not exceed the amounts established by
management, and the board has established reasonable total change
funds;
0 The credit union adheres to management’s established maximum

teller drawer limitations and maximum teller transaction
limitations. Tellers sell their excess teller drawer cash to the vault
change fund during days of high transaction activity;
0 Supervisory committee, internal audit department, or other

appropriate personnel perform periodic random audits of teller
change funds;
The credit union has procedures in place to immediately remove

terminating tellers’ access to cash operations and to audit, seal or
close, vacationing tellers’ drawers on their last work day;
0 Management restricts tellers, both by policy and computer

authority, from processing transactions on their own accounts,
accounts of family members, or accounts of other relatives;
Page 9-6
CASH ANALYSIS
0 Management restricts tellers’ computer authority, in terms of

access levels, and has controls in place to identify teller
transactions by unique teller stamps, teller codes, or ID numbers;
0 Management instructs employees to keep confidential their teller

log-on IDS and passwords and periodically changes IDS and
passwords;
0 The computer has an activated time-out feature that requires tellers

who are away from their stations for an extended period of time to
sign-on again. If the credit union has not activated the time-out
feature, tellers should sign-off when away from their stations for an
extended period of time;
0 Tellers lock their drawers when away from their stations and
secure their funds in the vault overnight;
0 Management restricts a teller’s access to an individually assigned

drawer and uses dual controls to prevent unauthorized access to
teller drawers;
0 The credit union clears any checks accepted in processing member

transactions daily and prohibits tellers from holding cash items
(checks, IOU’s, drafts, etc.) as part of their change fund balance;
0 Debit or credit memos signed by both parties evidence cash

purchases from and cash sales to the vault change fund. Credit
unions should prohibit cash purchases and sales between tellers;
0 The credit union maintains a clear audit trail by promptly and

accurately recording to the general ledger all cash activity,
including teller differences. Supervisory personnel should regularly
review the cash transactions records;
0 The credit union provides transaction receipts to members for all

transactions;
The credit union does not have a “slush fund” built over time by
overages that a staff member could use to conceal shortages;
Page 9-7
EXAMINER’S GUIDE
0 The credit union adequately segregates “bait money” to prevent

teller usage;
0 Management maintains dual control access to night depository

funds and mail deposits, and requires the presence of both persons
when removing, processing, and logging the contents;
0 Teller change fund policies, practices, procedures, controls, and

balancing procedures provide for adequate safeguards over teller
operations and accountability; and
0 Amounts in tellers’ drawers do not exceed surety limits, if surety

specifies limits.
If examiners encounter significant weaknesses as a result of the cash

review, they may request a controlled random or total teller drawer
count or perform a review of individual teller transaction reports.
Vault Change The vault change fund generally represents the largest portion of cash
Fund Review inventory and may fluctuate from time to time depending on
anticipated transaction volume, temporary, seasonal, and projected
demands. Because of the volume and fluctuation, the credit union
should internally balance the vault change fund daily. If examiners
review the vault change fund, they should consider that management
has instituted the following:
0 Master Log, listing end-of-day vault cash balances, maintained by

head teller or operations manager;
End-of-day vault change fund counts signed by head teller or

operations manager;
0 Vault change fund general ledger detail;
0 Reasonableness of the amount maintained in the fund (including

the teller change fund) for the needs of the credit union;
Page 9-8
CASH.ANALYSIS
0 Adherence to maximum vault change fund limitations established

by the board of directors, which should correspond to limits
established by the bylaws and any applicable surety limits;
0 Periodic audits of the vault change fund by the supervisory

committee, internal audit department, or appropriate personnel;
0 Restricted access to the vault change fund for accountability, both

by policy and vault combination or key distribution;
0 Required dual control for opening and counting vault change fund
replenishments, and signed bank debit memos evidencing the
replenishments. Ideally, management should maintain a cash
shipment log, and the timing of cash shipments should vary to
reduce recognition of an identifiable pattern;
Restriction of computer access levels for persons having access to

the vault change fund. Examiners should review the employee
transaction access limitation report to determine adequacy of the
credit union’s controls in this area;
0 Maintenance of a clear audit trail by promptly and accurately

recording to the general ledger all vault change fund activity,
regardless of whether the fimd is fixed or floating. Staff should
record and promptly resolve any cash differences;
0 Two-part debit or credit memos signed by both parties evidence

cash purchases fi-om and cash sales to the vault change hnd.
Examiners should trace a few transactions;
0 Implementation of procedures to prevent an employee responsible

for both vault cash and a teller cash drawer from commingling the
funds; and
0 Adequate safeguards and accountability over vault cash operations

provided by vault change fund policies, practices, procedures,
controls, and balancing procedures.
Page 9-9
EXAMINER'S GUIDE
ATM Change The credit union must internally balance the ATM change fund daily,
Fund Review recognizing, however, that it cannot perform a true balancing until it
replenishes the ATM and verifies the remaining cash, records deposits,
and records withdrawals to machine output reports or audit tapes.
If examiners review the ATM change fund, they could ensure the ATM
audit tape totals, adjusted for reconciling items, balance to the general
ledger ATM change fund balance. Examiners can verify randomly
selected individual reconciling items to source documentation, ATM
detail tape, or general ledger detail.
During this review process, the examiner could also determine that:
Management maintains dual control for opening, counting,

replenishing, and balancing ATMs;
Management maintains ATM deposits under dual control with both
responsible employees present during opening, listing, and
processing of machines and envelopes;
Management prohibits personnel having custody of member access
cards from having access to personal identification numbers;
Management properly segregates duties involving the balancing of
individual ATMs and balancing of system totals;
Supervisory committee, internal audit department, or other
appropriate personnel periodically audits the ATM change fund;
Management assigns an employee having no duties nor
authorizations in the teller or ATM areas of operation
responsibility for captured ATM cards; and
ATM change fund policies, practices, procedures, controls, and
balancing procedures provide for adequate safeguards over ATM
cash operations and accountability.
If the credit union owns several ATMs, these machines can hold a
substantial amount of cash. Some credit unions (usually those
maintaining large cash reserves) contract with outside parties, such as
armored car services, to replenish and service their ATMs. The credit
union should have agreements in place with bonded third parties. The
supervisory committee, or other appropriate personnel, must
periodically audit and verify these cash reserves, per specifications of
surety.
Page 9-10
CASH ANALYSIS
Bank Examiners may verify the most recent month-end bank reconcilement
Account and review at least one other randomly selected month-end bank
Review reconcilement. When credit unions use a corporate credit union for
their primary banking purposes, examiners apply the same review
procedures to the corporate account reconcilement. Examiners may
verify and review at least the following:
0 Bank reconcilements for (1) the most recent month-end, (2) the
randomly selected month-end, (3) the reconciliation preceding the
most recent month-end, and (4) the reconciliation preceding the
randomly selected month-end. Examiners need these four bank
reconcilements to verify outstanding items and adjustments for the
two months’ reviews selected;
0 Original bank statements correspond with the reconcilements

chosen for verification and review, and the current month’s
original bank statement, if available. If examiners do not have the
current month’s bank statement available and if they note unusual
activity, they may decide to order a cut-off bank statement;
0 Outstanding check registers and canceled checks correspond with

the reconcilements chosen for verification and review. When the
bank truncates the credit union’s checks, examiners may substitute
voucher copies for canceled checks. Examiners should trace a few
checks to the general ledger and bank statement to ensure the
checks agree with the amount on the reconcilement;
0 Bank stamped original deposit receipts and original bank debit and
credit memos correspond with the reconcilements chosen for
verification and review;
0 Original corporate account statements correspond with the

reconcilements chosen for verification and review;
0 List of authorized signers on the bank accounts (trace to board

authorizations); and
0 Bank accounts general ledger detail.
Page 9-11
EXAMINER’S GUIDE
If examiners review bank account reconcilements and statements, they

may include the following steps:
Tracing the book balances to the general ledger and reconciliation

of bank statement balances to the bank statements;
0 Footing the credit union’s bank reconcilements and corresponding

outstanding check registers;
0 Tracing all reconciling items to source documents, and to statement

or general ledger details;
0 Verifying that previous month’s outstanding checks cleared on the

month of review’s bank statement for the amount shown on the
previous month’s outstanding check register;
0 Reviewing aging of reconciling items, non-sufficient funds (NSF)

items, and outstanding checks. Generally, credit unions should
appropriately clear items older than 90 days unless staff is
researching them or settling a dispute (i.e., staff should not clear
such aged items to another suspense-type general ledger account
rather than resolving the problem);
0 Reviewing management aging report detailing suspense-type

general ledger accounts to ensure proper monitoring and clearing;
0 Verifying that the previous month’s deposits-in-transit cleared the

month of review’s bank statement for the amount shown on the
previous month’s reconciliation. Tracing the most recent month’s
deposits-in-transit as shown on the reconciliation to bank stamped
deposit receipts or current month’s bank statement, if available.
Credit unions should make deposits promptly as specified in the
FCU Bylaws. If necessary, the deposit-in-transit review may
include a random review of receipts to deposits. Staff should not
clear deposits-in-transit to another receivable-type general ledger
account;
0 Reviewing the origin and destination of a random sample of wire

transfers provided on the bank statements and verifying that the
credit union posted these wire transfers to the general ledger or
Page 9-12
CASH ANALYSIS
carried them as reconciling items. While the destination of wire

transfers is generally the corporate account, examiners should trace
destinations to other than the corporate account to source
documentation from the originator;
Determining the credit union adequately controls non-FEDWIRE

transfers. Sound controls require that the originating bank or
institution confirm the transfer with appropriate personnel not
responsible for initiating the transfer;
Reviewing canceled and outstanding checks for unusual payees,

unusual dollar amounts, or unauthorized signatures;
Verifling that staff properly marks voided checks “VOID’, and

crosses or cuts out the signature portion of the voided check or,
more importantly, punches the MICR line;
Determining the reasonableness of the volume of bank account

activity and average bank account balance in relation to the credit
union’s asset size, volume and amount of member transactions, and
compensating balance requirements;
Determining that the supervisory committee, internal audit

department, or other appropriate personnel periodically audits bank
account reconcilements; and
0 Reviewing that bank account reconciliation policies, practices,

procedures, and controls provide for timely reconcilements,
adequate safeguards over the bank account, and accountability.
Credit unions should complete reconcilements by the due date of
the financial statements as specified in the bylaws.
If the bank or corporate account reconcilements are more than 60 days

in arrears, examiners should reach agreement with the credit union to
bring the reconcilements current, usually within 30 days. If the
reconcilements are six or more months in arrears, the credit union is
deemed to have serious and persistent recordkeeping problems (per
97 15.12 of the NCUA Rules and Regulations) requiring the credit
union to hire an outside, independent auditor to perform an opinion
audit. When reconcilements are seriously in arrears, the examiner may
Page 9-13
EXAMINER’S GUIDE
perform a simplified bank reconciliation to determine how close the

bank balance is to the book balance and verifying, to the extent
possible, outstanding checks and deposits-in-transit.
When the credit union has not properly reconciled accounts or properly
researched and corrected adjusting entries, examiners should follow-up
to determine that the credit union makes the needed corrections.
Examiners should discuss the necessary level of supervision with the
supervisory examiner.
Credit Bank Examiners should not criticize credit unions for having a credit
Account balance in the cash account when the credit union has not overdrawn
Balance the bank account. Likewise, examiners should not criticize credit
unions for overdrawing the bank account infrequently, if the credit
union has a written agreement with the bank indicating the bank‘s
willingness to honor checks drawn by the credit union, even though the
credit union may not yet have sufficient funds deposited. Examiners
should review the costs credit unions must pay when they overdraw
their bank account; the costs may be higher than if they had borrowed
the funds.
Conversely, if the credit union regularly overdraws its bank account

and has no written agreement, it should increase the account balance
accordingly. Additionally, if the credit union frequently overdraws its
account, with or without a written agreement, examiners should
analyze the effect on liquidity and operating costs. Frequent overdraws
could indicate liquidity risk, transaction risk, and reputation risk.
Sweep Some banks offer a “sweep account” feature to their customers, which
Accounts allows the bank to sweep some or all of the balance of the credit
union’s bank account into some form of overnight marketable
securities. Using this feature, the credit union can often improve
earnings on its bank account. However, the credit union generally
bears all of the market risk liability inherent in the sweep transaction.
If examiners identify sweep account arrangements that warrant review,

they should determine that (1) a written agreement exists between the
bank and credit union, (2) the agreement should coincide with the
Page 9-14
CASH ANALYSIS
credit union’s investment policies and practices, (3) the credit union
has an acceptable market risk liability, (4) the bank records the sweep
transactions in the credit union’s name, and (5) the bank sweeps the
credit union’s cash into investment securities permissible for credit
unions.
Treasurer’s Treasurer’s drafts are drafts that a credit union issues against itself and
Drafts uses in the same way it would use a checking account at a bank. The
credit union does not establish a share draft account for itself. It merely
issues drafts that it promises to honor when properly presented. The
treasurer’s draft is an alternative to the bank checking account and
allows the credit union to use the float to its advantage.
Credit unions establish treasurer’s drafts by using a clearing account at

the payable-through bank. The drafts, issued for loan disbursements,
share withdrawals, and expense disbursements, clear in the same
manner as the members’ share drafts. As the payable-through bank
receives the drafts, it pays them from the credit union’s clearing
account at the payable-through bank.
Official “Official check” programs (e.g., Travelers Express, American Express)

Check often appeal to smaller credit unions that do not have their own
Programs checking account at a bank, although other credit unions may also use
this service. Each day the credit union writes drafts payable through a
bank. At the end of the day the credit union wires the total of the drafts
written to the official check company.
The credit union earns income on the float and once a month the
official check company sends the credit union a list of draft items not
cleared (the outstanding check list for the month.) This program does
not eliminate the cash reconcilement function. While NCUA does not
prohibit this program, default by the official check company could
negatively affect the credit union’s financial condition and reputation.
On-Us Share Frequently, larger credit unions use in-house share draft accounts for
Draft processing loan disbursements, share withdrawals, expense
Accounts disbursements, and even payroll. The process is similar to that of
Page 9-15
EXAMINER’S GUIDE
Treasurer’s drafts, but the credit union uses a share draft account rather
than a treasurer’s draft payable account. The on-us share draft accounts
serve as an alternative to the bank checking account and allow the
credit union to use the float to its advantage.
Examiners can identify these share draft accounts through (1) inquiries
with management, (2) review of canceled and outstanding drafts, and
(3) review of zero balance or overdrawn share draft reports. Account
numbers of such accounts generally begin with “9’s”. These are
actually liabilities and not share accounts. If a credit union uses on-us
share draft accounts, it can inflate or deflate actual total share account
amounts, which could affect the capitalization deposit.
At any given month-end, the balance remaining in these share draft

accounts actually represents outstanding drafts. The examiner could
determine that the credit union appropriately accounts for and controls
such accounts, and that it closes any remaining balance in these share
draft accounts to the related liability account before finalizing month-
end financial statements.
Money If examiners review money orders and travelers checks, which are
Orders and generally off-balance sheet consignment items, they could determine
TraveIers whether the following exists:
Checks
0 The credit union has adequate policies, practices, and controls to
safeguard these negotiable monetary instruments and provide for
accountability over the reserve supply and working supply;
0 The supervisory committee or other appropriate personnel

periodically reconciles the money orders and travelers checks;
0 Management maintains the inventory of money orders and travelers

checks at reasonable levels as governed by membership demand. If
the agreement also requires surety limits, the examiners should
review compliance with those limits;
0 The credit union opens, counts, and records the shipments of

money orders and traveler’s checks under dual control;
Page 9-16
CASH ANALYSIS
0 The credit union maintains records of serial numbers of money

orders and traveler’s checks held in the reserve supply and teller
working supply;
0 The credit union stores the reserve inventory and working supply
inventory in the vault during non business hours;
0 The credit union posts sales fees to the appropriate income

accounts daily;
The credit union sends sales remittances to the issuer promptly;

and
0 The credit union destroys money orders and travelers checks, if

necessary, under dual control and appropriately logs this activity on
a destruction log signed by both parties.
If the review of money orders or travelers checks discloses significant

procedural deficiencies, or if staff has not completed current
reconcilements, the examiner should observe staff performing an
inventory during the examination. As part of this inventory procedure,
the examiner should ask the credit union to request from the issuer a
listing of money orders and travelers checks issued, but not yet paid.
The examiner’s inventory should balance with issuer’s inventory. The
examiner must reach agreement with the credit union to resolve any
discrepancies between the two inventories.
Other Other negotiable items include, but may not be limited to, postage
Negotiable stamps and theater and amusement park tickets.
Items
Credit unions frequently sell postage stamps, theater tickets, and
amusement park tickets. If examiners review postage stamps, theater
tickets, and amusement park tickets, they should ensure that the credit
union performs inventories at least quarterly and has adequate internal
control procedures.
Excessive Examiners may incorporate reviews of specialized information systems

Transactions reports, such as the “Excessive Transaction Report”, into their
Page 9-17
EXAMINER'S GUIDE
evaluation of cash operations in automated credit unions. The credit

union can change the parameters on the Excessive Transactions
Report, but usually sets them to display transactions over $10,000.
While the $10,000 parameter is actually for Bank Secrecy Act (BSA)
compliance purposes, review of this report may reveal unusual or
excessively high transaction volume, which would necessitate further
investigation. Refer to the Bank Secrecy Act chapter.
Federal With any payment system, a sending institution may not be able to
Reserve's settle its obligations within a specified time. All FEDWIRE transfers
Payment are final and irrevocable when the Federal Reserve Bank (FRl3) sends
System Risk notice of the payment to the receiving institution. Therefore, the
Program receiving institution can pass collected funds immediately to its
customer and will bear no risk if the sending institution fails. If the
sending institution has insufficient funds in its reserve account at the
time the payment order occurs, it incurs a "daylight overdraft." If the
sending institution fails that day, before bringing its reserve account
into balance, the FRB absorbs the loss.
Systemic risk means the risk that a system participant's failure to settle
its net debit position will affect others. The major objective of the
FRE3's policy statement is to reduce the risk of a settlement failure. The
policy statement seeks to achieve this goal by reducing the level of
daylight overdrafts and by encouraging institutions to exercise better
control over the remaining credit exposure through voluntary adoption
of a "cross-system sender debit cap". This cap represents the maximum
net debit a depository institution may incur at any one time on all of
the large dollar wire transfer systems. It further limits the amount by
which an institution's outgoing wire transfers may exceed the value of
the transfers received across all systems.
Under the policy statement, the FRB encourages depository institutions

to establish their net debit cap based on a self-assessment of three
criteria:
(1) Creditworthiness;
(2) Operational controls, policies, and procedures; and
(3) Credit policies and procedures.
Page 9-18
CASH ANALYSIS
Based on the depository institution's evaluation of its strength in these

three areas, the FRB determines an overall assessment of the
institution. When a depository institution establishes its sender net
debit cap, the FRB expects the institution to maintain supporting
documentation, a back-up file of its self-assessment, and evidence of
its board of directors' review and approval of the cap selected.
Appendix 9A, Wire Transfers, provides additional information.
Fraud If examiners discover fraud or a shortage, they should document the

Detection fraud or shortage as completely as possible and notify the supervisory
examiner. With supervisory examiner concurrence, the examiner
should notify the board of directors and the supervisory committee and
request completion of the Suspicious Activity Report (SAR). The
examiner will encourage the officials to, at a minimum, (1) suspend
the personnel involved with pay, (2) control the access of personnel
involved to the credit union, (3) fill the operational void caused by the
suspension, (4) contract to perform a fraud audit, (4) notify surety, and
(5) file a bond claim after all facts are known.
Ultimately, NCUA must decide the likelihood of pursuing prohibition

actions against dishonest individuals. The examiner should seek input
for this decision from the supervisory examiner, regional office, and, if
necessary, the Office of General Counsel. Should conviction of a crime
result for an individual, NCUA usually can obtain a prohibition more
easily.
Alternative Internal control limitations, primarily the lack of segregation of duties

Examination due to limited staff, can exist for many smaller credit unions. When
Procedures examining non-complex smaller credit unions, examiners may
for Small substitute the following review procedures, which may adequately
Credit Unions address their internal control concerns in the cash area:
0 Observe staff count all cash in the presence of a credit union

official or manager, and determine that the count balances to the
corresponding general ledger accounts;
0 Determine that the reconcilements balance for two month-ends

since the previous examination, and documentation exists for
Page 9-19
EXAMINER’S GUIDE
reconciling items (e.g., deposit slips for outstanding deposits.)

Examiners may randomly select one month and confirm clearing of
reconciling items within reasonable time frames, but the second
month should be the most recent month-end bank reconcilement.
Review “stale” outstanding checks and outstanding adjustments
over 30 days old;
0 “Flip” checks. Select a representative month, look at canceled

checks for unusual activity (e.g., payee and check signer are the
same person, unusual endorsements, etc.);
0 Perform receipts and disbursements test for two months since the
previous examination. Examiners may randomly select one month,
but the second should be the month prior to the current
examination. The testing includes reconciling total debits and
credits of the general ledger with the total of debits and credits
shown on the bank statements. If the receipts and disbursements
test results in differences that need further review, the
reconciliation of receipts with deposits may pinpoint the
differences; and
0 Verify that the credit union makes deposits intact and within
timeframes consistent with the FCU Bylaws.
If examiners perform this type review, they should document their

review.
Receipt and The purpose of the receipts and disbursements test is to quickly
Disbursement determine whether or not cash receipts and disbursements posted to the
Test credit union’s books tie out to the actual receipts and disbursements on
the bank statement. This test will help identify falsified deposits and
checks, month-end lapped deposits, and several other areas of cash
manipulation; however, examiner’s judgment is needed to determine
the cause of the problem.
Receipts Test 1) Place the total of the receipts from the general ledger in a cell on
the computer or in the memory of a calculator;
2) Total the deposits on the current bank statement;
Page 9-20
CASH ANALYSIS
3) Subtract the outstanding deposits from the previous month as

shown on the bank statement, since this represents activity from
the previous month. Also, verifL that the prior month’s deposits
appear intact on the current bank statement;
4) Add the outstanding deposits for the current month;
5) Subtract the total of the current month’s outstanding deposits (Step
4)from the stored total of general ledger receipts (Step 1):
- If the answer is zero (i.e., the receipts equal the deposits), no

apparent problems exist;
- If they are not equal, determine the source of the difference.
Small differences often represent re-deposited, non-sufficient
funds (NSF) checks. Examiners should look for credit and
debit memos and determine how they affect the statement.
Larger differences may require the examiner to check the
deposits back individually to determine if an error occurred
(see reconciliation of receipts with deposits).
Disbursements The procedures are similar to those for the receipts test, except they
Test involve checks written and cleared instead of deposits. Again, if the
test does not zero out, determine the reason for the difference. Reasons
may include NSF checks, service charges, check printing fees, or other
reconciling items. Examiners may find it necessary to prove out the
daily totals by running tapes of each day’s checks when they cannot
readily determine the differences or when they suspect fraud.
Examiners should be able to perform these tests quickly to uncover

posting or other problems. They may develop spreadsheets to speed the
work and allow the computer to do the calculating.
Reconciliation Of Examiners may choose the test check of tracing or reconciliation of

Receipts with receipts, as recorded in the credit union’s books (or tellers’ cash
Deposits received summaries, if not posted), with deposits recorded by the
bank. Examiners may use this test check in situations where the
receipts and disbursements test indicates problems that require further
research. This test also supports and ties in the cash count and the bank
reconcilement.
Page 9-21
EXAMINER’S GUIDE
The reconciliation of receipts with deposits documents that the credit

union makes bank deposits intact (i.e., the deposits include the exact
amount of one or more day’s receipts) and deposits them in the bank
within the time limitations set forth in the bylaws. Additionally, this
test determines that the credit union does not summarize receipts of
more than one day on the same cash received summary. (The credit
union should prepare a cash received summary each day and attach it
to that day’s individual teller cash received summaries.)
Examiners could trace funds received from entries on the credit

union’s books (or tellers’ cash received summaries, if not posted) to
evidence of deposits in the bank. The suggested minimum period starts
with the beginning of the month prior to the month in which the
examination takes place and runs through the day of the cash count.
The purpose of this test check is to furnish the examiner with a
reasonable appraisal of the credit union’s practices with respect to
depositing of funds received.
and - Red Flag Questionnaire
References - Cash Internal Control Questionnaire
- Money Order and Travelers Checks Questionnaire
- ATM Questionnaire
References
- NCUA Rules and Regulations - 7 15.12
- FCU Bylaws - 12/87 - XV,l .
- FCU Bylaws - 10199 - XIII, 1.
Page 9-22
WIRE TRANSFERS - APPENDIX 9 A
Overview An electronic funds transfer (EFT) is any transfer of funds initiated
through an electronic terminal, telephonic instrument, computer, or
magnetic tape for the purpose of ordering, instructing, or authorizing a
financial institution to debit or credit an account. Credit unions
primarily use wire transfers to transfer their own funds (e.g., for
investments or payment of expenses) from one institution to another.
However, credit unions also transfer members’ funds upon request.
The majority of credit unions wire funds by calling their corporate

credit union (or correspondent bank) and instructing the corporate to
(1) access the credit union’s settlement account at the corporate to fund
a wire transfer, (2) forward the funds and the wire instructions to the
Federal Reserve, and (3) post the transaction to the credit union’s
settlement account at the corporate.
Credit unions that have an Internet-based request system may also

submit requests for wire transfers to the corporate credit union or
correspondent bank electronically. Many larger natural person credit
unions directly access the FEDLINE system (or telephone the Federal
Reserve directly) and conduct their own transfers. (FEDLINE, the
personal computer-based electronic delivery system by which credit
unions access the Federal Reserve System’s on-line services and
information, provides settlement services, cash services, and a means
to transfer funds and securities between institutions.)
In any case, all credit unions offering wire transfers must abide by
written security policies and procedures that consistently promote safe
and accurate transactions. Credit unions can limit their liability and
risk of loss by using recommended security procedures, referred in
UCC Article 4A as “commercially reasonable security procedures”
(e.g., recorded telephone lines, codes, passwords, personal
identification numbers (PINS), encryption, etc.) These procedures help
assure the authenticity and correctness of payment orders, and apply to
telephone, personal computer, or other electronic transmission of the
orders to the credit union.
Page 9A-1
EXAMINER'S GUIDE
Transaction Credit union officials must write and adhere to transaction security
Security policies. Examiners should review the written policies and determine
their appropriateness for the credit union's size and number of
employees. Examiners should also request the list of employees
authorized to initiate wire transfers and review it to ensure the credit
union keeps it current.
Proper controls depend on accountability (including accurate

recordkeeping and sufficient documentation) and adequate separation
of duties, which small credit unions having few employees can find a
particular challenge. Nonetheless, all credit unions involved in wire
transfers should carefully develop and strictly adhere to good internal
controls.
Most corporates, correspondent banks, Federal Reserve or FEDLINE

terminals mandate that credit union employees authorized to send
funds by wire identify themselves by passwords, PINS, or test keys.
The credit union should require frequent changing of passwords,

depending on the volume of wire activity (e.g., credit unions should
change FEDLINE passwords every 30 days and members' passwords at
least semiannually.) Credit unions that require regular changing of
passwords reduce the risk of an unauthorized user gaining access to a
member's account.
The examiner should determine that the credit union properly controls
the system of assigning and communicating passwords, and that it
promptly acts on suspected compromises of this security by canceling
the password and assigning a new one. Examiners should walk through
the wire transfer procedure with the credit union staff. Following are
examples of controls that credit unions should enact:
Assign a unique password to each user. Sharing passwords

increases the potential to compromise control and accountability;
Discourage users from selecting easily remembered passwords

(e.g., initials, family member's name), or ones that rotate in a
pattern, by using PINS or test keys;
Page 9A-2
WIRE TRANSFERS - APPENDIX 9A
0 Ensure confidential and secure communication of newly-selected

passwords, PINs, or test keys between the credit union and
employees authorized to perform wire transfers;
0 Instruct employees to close files, turn computer screens from the

view of other employees, and refrain from discussing confidential
information, including passwords; and
0 Control access to the system, passwords, and any backup software

when storing passwords on a shared electronic system such as a
local area network (LAN.)
Requests for To positively identifL members, credit unions should require members
Wire requesting a wire transfer of any amount to complete and sign a
Transfers standard authorization form. However, many members make requests
for emergencies when the member cannot come to the credit union. In
these cases, the credit union should attempt to identify the member
over the phone and establish a limit for the amount it will wire under
these conditions. Requesting account numbers, social security
numbers, or birth dates does not meet minimum security standards for
wire transfers. Information not easily accessible to someone other than
the member requesting the wire is acceptable (e.g., mother’s maiden
name, password, etc.) Written procedures should establish a maximum
limit (i.e., an amount the credit union has determined it could lose in
an unauthorized wire - usually $2,000-$3,000) for wires requested by
telephone.
For members regularly requesting telephone wire transfers, the credit

union should establish passwords or PINs which it changes routinely.
In addition, regular users should sign formal wire transfer agreements
that fix responsibility between the parties. The credit union should
maintain the agreements on file.
The credit union needs to document wire requests. It must understand

that a FAX does not comprise a legal document. Phone calls, unless
made on recorded lines, are also difficult to prove; therefore, the credit
union should consider installing a telephone recording system on
phone lines used for wire transfer calls. At a minimum, the credit
union should call back the member to verify authorization of the wire
Page 9A-3
EXAMINER’S GUIDE
transfer and record on the wire form the date, time, and initials of the
person receiving the request and the person performing the callbacks.
Various credit union departments making wire requests for

investments or payment of expenses should record those requests on
standard request forms after obtaining approval from individuals
authorized to make investments or pay expenses.
Methods of Most credit unions wiring through their corporate or a correspondent

Sending Wire bank call the institution and request the transfer or submit the request
Transfers for transfer using a product such as U.S. Central Credit Union’s Open
Door system or another institution’s browser-based transaction
program. Authorized users state or enter their passwords or PINS and
make or enter the request.
Corporate staff should read back a telephone request order to the

requesting credit union for accuracy and may confirm the request by a
telephone callback. For Internet based programs, the corporate will
probably employ automated checks for accuracy; but may confirm the
request through a telephone callback.
Corporate staff should ensure the caller has authority to make the
request, and that the requested amount falls within the caller’s
authority. Most often the credit union’s responsibility includes
assigning authority to request wires to specific employees and
assigning a maximum dollar limit on each employee’s authority. The
corporate then verifies the caller’s authorities to a listing provided by
the credit union.
Passwords and callbacks have different purposes and should not

substitute for each other. Passwords allow a user into the system, while
callbacks confirm the order’s source and authenticity. Credit union
management may not always recognize this distinction.
Less common (and inappropriate) methods of requesting wire transfers

include telegram, telex, and FAX. The ease of compromising the
security of these transactions provides each with a great potential for
fraud. The examiner should take exception to a credit union’s use of
any of these methods.
Page 9A-4
Assuming the credit union has adequate security and proper controls,
examiners should not take exception to other forms of electronic
transfer, such as Western Union wire terminals, or alternative software
such as U.S. Central Credit Union's Open Door product or other
browser-based wire request programs.
Pre- Credit unions establish many repetitive wire transfers (e.g., regular or
Authorized periodic transfers of credit union funds to an investment account at
(Card) Wires another institution.) For these repetitive wire transfers, the wiring
instructions remain the same except for the dollar amount.
The receiving institution (usually the corporate or Federal Reserve)

often establishes pre-authorized (card) transfers by creating a template
screen in the FEDLINE terminal or within the browser-based
transaction program. Then, when the credit union calls in or submits a
wire request via the Internet, the caller or person entering the request
only gives or enters a password or PIN number and states the need for,
or enters, a wire for a certain dollar amount in the credit union's
account at "ABC Bank." The caller does not have to give an account
number or the bank's ABA number, which results in a more efficient
transaction.
The examiner should review the security procedures for establishing,

changing, or deleting the credit union's template screen on the
FEDLINE terminal or within any browser-based wire request
programs. Adequate accountability and control requires a written and
confirmed request to establish, change, or delete a pre-authorized
template. Additionally, someone other than the operators performing
the "initiation" and "verification" functions on the terminal should
establish or edit the template screens.
FEDLINE A credit union having its own FEDLINE terminal must institute
Term inaI additional controls and security measures beyond those required for
accessing the FEDLINE through a corporate or correspondent bank.
Funds transfer messages sent over the FEDLINE terminal must go

through two processes before transmission. Initiation involves entering
the message into the terminal, while verification requires re-entry into
Page 9A-5
EXAMINER’S GUIDE
Sample FEDLINE User Access Report
Local Administration MMIDDiYYYY 14:09:03L 2 K 1 9

*MC-F6*
User-ID: Name:
Password: Verify password:
Current states: A Password last changed on: re-try cnt:-
An ‘X’ designates what function categoly a user is allowed to access with an application. No ‘X’s imply
non-restricted functions only.
I I
Application 1 Function categories I
Code I Inq. ; EN ; V/T ; A.Supv. ; Supv. ; Mngr. ;
I I I I I I I I
I I I I I I I I
I I I I I I I I
I I I I I I I I
I I I I I I I I
I I I I I I I I
I I I I I I I I
I I I I I I I I
I I I I I I I I
I I I I I I I I
I I I I 1 I I I
I I I I I I I I
Sample Miscellaneous Security Settings Report

Misc. Security Settings Local Administration MMIDDNYYY 9:37:58L 6.38
LOCAL ADMINISTRATION ACCESS OPTIONS
User’s ID will be suspended after 3 consecutive bad password attempts
User must change password every 45 days
Verification rule N (use < F6 > Key)
Override & Release rule N (use < F6 > Key)
User-ID will be signed-off after 15 minutes of inactivity
Illustration 9A-1
Page 9A-6
the terminal of all or part of the message. The security options on the
system allow the credit union to decide exactly which data fields
within the message it will re-enter. After staff completes the
verification process, the FEDLINE terminal automatically transmits
the message and transfers the funds.
The examiner should determine that the credit union requires two
different employees to perform the initiation and verification processes
on the terminal. Both the credit union's written policies and its
established control parameters on the system should require this
separation of duties. Examiners should ask the local administrator to
screen print the "Miscellaneous Security Settings" for purposes of
reviewing the controls. (Illustration 9A- 1 contains examples of the
FEDLINE User Access Report and Miscellaneous Security Settings
screen print.)
IVh~llaneous The examiner should have the local administrator screen urint the
Security Miscellaneous Securities Settings during the examination. The screen
Settings print will show:
Settings for the Verification Rule;

The Override and Release Rule;
The number of bad password attempts allowable before the system
suspends a user ID;
The number of minutes the system allows the FEDLINE terminal
to remain unattended before it automatically logs off;
Whether the system suppresses the keyboard eavesdropping
message each time a user enters the FEDLINE; and
Whether the system prints a h l l or summary account of deleted
transactions during the cycle-date rollover.
Verification The Miscellaneous Security Settings screen displays the setting of the
Rule "verification rule" to N, U, or E. The "N" designator allows the same
FEDLINE operator to perform initiation, editing (if needed), and
verification functions on the same message. In other words, this
designator allows one FEDLINE operator to transmit funds. The "U"
designator restricts the FEDLINE operator who last initiated or edited
a message from verifLing that message. Thus, this designator requires
Page 9A-7
EXAMINER'S GUIDE
at least two FEDLINE operators to transmit funds. The "E" designator

is the most restrictive. It requires that a FEDLINE operator other than
the initiator or the editor perform the verification function.
The "N" designator for the verification rule does not require adequate
separation of duties; therefore, it is unacceptable for credit unions.
Larger credit unions should set this designator at "E" thus requiring the
highest level of separation of duties. However, the examiner may
accept a setting of "U" for the verification rule, especially if the credit
union has limited staff, and if, in the examiner's judgment, it has other
adequate controls.
FEDLINE A two-character code identifies each application in FEDLINE. The

Functions following codes assign access authority to an operator:
and Access
Levels ** All Applications
AH Automated Clearing House
AS Accounting Services
BA Book-Entry Securities
cs Cash Services
CH Check Services
FT Funds Transfer
HC Host Communication
HD Help Desk
LA Local Administration
MS Miscellaneous Support
RA Local Reserve Account
RR Reporting and Reserves
SB Savings Bond
ss Startup/ShutdownControl
ST Securities Transfer
TA Treasury Auction
TT Treasury Tax and Loan
The following six access levels exist within each application:
0 Inquiry
0 EntryAJpdate
0 Verify/Transmit
Page 9A-8
0 Assistant Supervisory
0 Supervisory
Managerial
The credit union can assign an employee one or more access levels
within an application; they need not be the same for each application.
For example, the credit union may give an employee inquiry capability
for the Securities Transfer (ST) Application, and managerial capability
for the Funds Transfer (FT) Application. Also, the credit union need
not assign all six levels of access within each application.
The credit union may choose to customize some local options in

accordance with the institution's specific operating environment. These
rules apply to the entire FEDLINE system installed on the computer,
not to a specific application.
The local access options are:
0 Number of invalid password attempts;

0 Password expiration interval;
0 Key verification requirements;
0 Override and release rule;
0 Automatic sign-off and time-out intervals;
0 Suppression of possible keyboard eavesdropping; and
0 Cycle-date rollover print delete option.
Local The credit union will designate one or more employees as a local
Administrator administrator for the FEDLINE terminal. The local administrator may
add or delete authorized users and authorized functions of established
users. (For example, funds transfer is only one of several functions.
Others include securities transfers, ACH transactions, etc.) The local
administrator can also select, add, delete, or change an individual's
security options.
The local administrator should be an employee who works outside the

operational area responsible for the terminal and who the credit union
(1) would challenge for trying to gain terminal access routinely, and
(2) will not assign any other duties on the FEDLINE terminal. The
Page 9A-9
EXAMINER'S GUIDE
examiner may have to make certain allowances for the limited staff in
a smaller credit union.
User Profile During the examination, the examiner should identify and ask the local
Report administrator to print out FEDLINE'S User Profile Report in the
examiner's presence.
The User Profile Report shows all authorized users, the functions each
may perform, and the authority level within each authorized function.
The examiner should identify all users on this report and determine
that the credit union has broad enough authorization levels to allow
staff to efficiently carry out their duties and responsibilities, yet
sufficiently restricts these authorization levels to ensure sound internal
controls.
The examiner should pay particular attention to the following function

codes:
0 ** (Double asterisk) - Allows the user to perform any function

0 LA - Local administrator function
0 FT - Funds transfer function
ST - Securities transfer function
Anyone with the "**" function code can perform any function. The
examiner should determine the appropriateness of giving such
widespread authority. Two different employees should always perform
the initiation and verification functions. However, when possible,
NCUA strongly encourages greater separation of duties.
As mentioned earlier, the personnel authorized to perform the LA

function should not have authorization to perform any other function.
Under certain circumstances, a local administrator could unilaterally
set himself up to perform other functions at any time. However, the
additional time required to set up the new authorization and the
attention that would result from the local administrator being at the
terminal, as well as constant internal auditing and monitoring of
FEDLINE activity, should deter any unauthorized actions by the local
administrator. Internal auditing and monitoring of the FEDLINE
Page 9A-10
system should include review of user access by someone not involved

in the funds transfer process, other than the local administrator.
The FT code designates those employees who may perform funds

transfer functions. The examiner should determine that the credit union
has assigned this code to the minimum number of employees necessary
for efficient operation. No employee outside the funds transfer
department should have authorization to perform the FT function at
any level higher than "inquiry."
The ST code designates those employees who may perform securities

transfers on the FEDLINE terminal. Examiners review the use of this
code in conjunction with the examination of the credit union's
securities safekeeping program.
User Access The examiner should ask the local administrator to print the User
Report Access Report.
FEDLINE 0 Number of password tries. Every user on the FEDLINE terminal

Security has a personal password that the system requires before an
Features individual can perform any function. The system requires periodic
change of personal passwords. The local administrator can set the
number of times a user may enter an erroneous password before the
system locks out that user's ID. The miscellaneous security settings
screen shows this setting.
The examiner should determine the appropriateness of the number

of password-attempts setting. Normally, the credit union setting
should allow no more than three bad attempts.
0 Override and Release Rule. This setting, which restricts the

overriding and releasing of messages, has available the same three
options as the verification rule.
0 Automatic log-off of unattended FEDLINE terminal. The

miscellaneous security settings screen also states the number of
minutes that the FEDLINE terminal will stay active before
automatically logging off. The local administrator can set this
Page 9A-11
EXAMINER’S GUIDE
parameter at any number from 0 to 999. If the local administrator

sets this number at other than zero, the terminal will automatically
log off after being left unattended for the pre-set number of
minutes. If the local administrator sets the number at zero, the
terminal will not log off automatically.
If the local administrator sets the time parameter too long, chances
increase that one operator may gain access to the terminal while it
is still logged on under another operator’s user ID, resulting in a
loss of accountability.
The examiner should review the unattended FEDLINE terminal

setting and determine its appropriateness. Normally, the credit
union should set the parameter between one and five minutes.
Suppress Possible Keyboard Eavesdropping. This setting permits

the administrator to turn off the “possible keyboard eavesdropping”
message noted each time a user enters FEDLINE.
The examiner should determine that the administrator has not

suppressed the message. The credit union should enact and monitor
a control preventing a Terminate and Stay Resident (TSR) program
on the terminal to ensure that no one copies various keystrokes.
Cycle Date Rollover. Before beginning each day’s work, a credit

union employee must perform a function on the FEDLINE terminal
known as the “cycle date rollover,” which resets the date on the
terminal. The FEDLINE system requires the operator to clear or
cancel messages still pending (i.e., initiated but not verified or
transmitted) before performing this function. The policies should
require canceling and reporting to management any pending
messages.
The security administrator can set the system to print either a full
or a summary account of deleted transactions during the cycle-date
rollover process. Either report documents pending message
problems. While the detailed report contains all the information
about the transaction, the summary report shows only limited
information about the transaction.
Page 9A-12
0 Update Message Application Attributes. This function allows staff

persons with managerial access to customize several control related
aspects of outgoing message processing including: verification
thresholds, a duplicate reference number edit, and an accountable
message transmission limit. Management can establish these
verification requirements for the message processing functions at
the application level for Funds Transfer, Securities Transfer,
Checks, or Treasury Tax and Loan (TT&L) messages. Examiners
can determine whether the credit union has set any of these
customized features by asking that the staff person with managerial
access to the applications screen print the settings on the update
message application attributes’ screens.
The credit union can set verification thresholds for accountable and
non-accountable messages for which it will impose the verification
requirement. If the credit union sets the dollar amount at 0.00, it
will verify all messages; whereas, if the credit union sets the dollar
amount at 99,999,999,999.99, it will verify no messages. For other
settings, it will verify any amount over the amount set. NCUA
recommends that the dollar amounts be set at 0.00 to verify all
messages.
The credit union can automatically check for duplicate reference

numbers when creating or updating information depending on the
numbering of source documents. Good internal controls require
activation of this edit check to prevent duplication of numbers.
Examiners should determine that the credit union uses a different
number on each source document.
Credit unions can prevent transmission of accountable messages

(including those with a verified status) until an authorized operator
using the message status override function releases the messages.
Credit unions with larger staffs usually activate this additional
control; however, credit unions with smaller staffs often set the
control at “N’ indicating that the system will automatically que
verified messages for transmission. Examiner’s judgment will
determine the adequacy of the setting.
Page 9A-13
EXAMINER'S GUIDE
Reconc iI- The credit union should reconcile the number and dollar amounts of
iation of the funds transferred to the Federal Reserve account balance throughout
FRB Account the day. Periodic reconciliation discourages fraud. Smaller credit
and Funds unions may reconcile only two or three times during the day; larger
Transfers credit unions more often. In addition, staff must perform a detailed
reconciliation of the Federal Reserve account daily. The individual
responsible for reconciling should not otherwise perform funds transfer
duties.
Audit copy of A FEDLINE printer records messages on the FEDLINE terminal.

FEDLINE There are three categories of messages:
Messages
0 Outgoing transactions;
0 Incoming transactions; and
Miscellaneous messages.
The credit union can have all messages going to the sanie printer, or
direct different categories of messages to different printers. The
FEDLINE system assigns a sequence number to each message. Each
category has a separate sequential numbering.
In order to establish an audit trail, the credit union should use multiple-
part paper on the FEDLINE printer. The credit union should maintain
one copy of the messages in continuous form for the entire day, from
log-on to log-off. If staff must perforate the paper (e.g., when the box
of paper runs out), a supervisor other than a FEDLINE terminal
operator should inspect the old and new continuous forms to account
for all messages and should initial the beginning and end of each form
where the gap occurs. Supervisory review of the entire audit trail for
unauthorized attempts to access the system, unauthorized messages,
etc., should occur daily. The supervisor should initial the audit trail
indicating the review. The credit union must retain daily audit trails
through both the next audit and examination periods.
Page 9A-14
Functions, Corporate credit unions or other third-parties, including correspondent

Applications, banks, provide a number of browser-based programs used by credit
and Security unions to submit wire transfer requests. Each program has its own
Parameters in defined functions, applications, and security parameters. While each
Browser- program has differences, the hnctions, applications, and security
Based parameters should essentially mirror the control features available
Systems using Fedline.
A wire transfer made through a corporate credit union or

correspondent bank using browser-based software rather than
FEDLINE does not change the need for involving two credit union
employees in performing the initiation and verification processes.
System parameters similar to FEDLINE controls should require this
separation of duties. Examiners should ask the browser-based program
local administrators to print out a screen similar to the FEDLINE
“Miscellaneous Security Settings” screen, showing the availability and
activation of a dual control feature. Browser-based programs also
generally provide for maximum dollar limits for each user. Usually,
examiners can verify the presence of dollar limits by accessing the
system’s User Authority Reports.
Phys icaI Following are important aspects of physical security:

Security
0 Location of the FEDLINE terminal. Ideally, the credit union should
locate the FEDLINE terminal in a secured room dedicated solely to
wire transfer activities, with only authorized terminal operators and
their supervisors having access. However, smaller credit unions
having limited space often cannot place the terminal in a secured
room. In that case, the credit union should place the terminal in a
low traffic area, but within sight of the workstations of all the
terminal operators or the operators’ supervisor. This reduces the
likelihood of unauthorized personnel gaining access to the
terminal.
0 Number of staff present. The credit union’s written wire transfer

policies and procedures should require the presence of at least one
employee who understands and can operate the FEDLINE terminal
and a supervisor whenever the FEDLINE terminal is operational.
Page 9A-15
EXAMINER'S GUIDE
Security of telephone lines. The examiner should determine the

security from eavesdropping of the credit union's telephone lines.
A breach of security could occur from outside or inside the
building. The telephone company bears responsibility for security
outside the building; security inside the building rests with the
credit union.
Examiners should evaluate the security of the room containing the

credit union's telephone switching panel (i.e., locked with
management maintaining the key) and determine that the telephone
system does not allow one extension to listen in on another system.
An unauthorized person could listen in on a telephone line at this
switching panel with the aid of relatively simple equipment. If a
repairman needs access to the panel, management should verify the
repairman's identification and take necessary precautions to avoid
breaches of security any time the panel is unsecured.
0 Security of encryption key diskette. The Federal Reserve provides

all authorized, licensed users with a diskette containing the
encryption key for the FEDLINE terminal. The terminal has a
security feature that requires the reload of the encryption key if the
credit union moves the terminal. FEDLINE licensing agreements
allow maintaining only two copies of the diskette; one copy at the
credit union and the other offsite for use during disaster recovery.
The credit union should keep both diskettes in secure areas with
controlled access, such as a safe or safe deposit box.
PoIicies, The AIRES Wire Transfers Questionnaire inquires about internal

Procedures, control practices pertaining to the wire transfer operation and, more
and specifically, whether the written policies and procedures address
Guidelines certain practices. Examiners should determine that employees follow
written procedures.
Written internal control procedures help ensure consistent application,

enforcement, and accountability, even when a change of staff or
management occurs. Appropriate procedures should include:
0 Written funds transfer agreements. The credit union should have a

written funds transfer agreement with each applicable institution,
Page 9A-16
outlining the duties and responsibilities of each party to protect the

interests of both institutions. The agreement should specify the
responsibilities of the institutions regarding security features such
as passwords, PIN numbers, test keys, and telephone callback.
The institutions should also have written documentation that

authorizes certain employees or officials to request or send funds
transfers. If this is the only documentation, the examiner should
take exception and require the development of a formal funds
transfer agreement.
Credit unions that send members' wires should also have written
agreements with their members notifying them of their duties and
responsibilities, assigning liability in the event of a loss, and
documenting the security procedures to be used.
0 Personnel policies for wire transfer operation. To enhance the

funds transfer operation internal controls, written personnel
policies should incorporate items that may help improve the credit
union's chances of collection if someone files a bond claim against
an employee who violates the policy. These should include
restricting or limiting the hiring of relatives for key areas, filling
vacancies internally, and eliminating access on termination or
resignation.
0 Contingency planning for wire transfer operation. The examiner

should determine that the credit union has an adequate disaster
recovery plan for its wire transfer operation, and that management
has sufficiently familiarized all wire unit employees with the plan.
Some credit unions, particularly those whose disaster recovery
plans include relocating to a "hot site," may have the capability of
remaining online with the Federal Reserve during a disaster. For
those, procedures and controls should remain much the same as
during normal operations. However, many credit unions plan for
their funds transfer operations to go offline in case of a disaster.
Either way, the credit union must maintain proper security over the
operation during execution of the disaster plan and must
periodically test the plan and document the test results.
Page 9A-17
EXAMINER’S GUIDE
0 Audit or review of wire transfer operation. The sensitive nature of

wire or securities transfers requires an audit or review at least
annually. The credit union’s internal audit department or external
auditors may perform the review. If the credit union has its own
wire or securities transfer system, it should hire auditors who have
independent training in the credit union’s wire transfer
communication system, and who participate in planning for
changes in equipment, systems, and operating procedures. The
auditors should establish a formal audit program covering all
aspects of the wire or securities transfer operation.
Record- The Federal Financial Institutions Examination Council (FFIEC)

keeping encourages credit unions to support law enforcement’s efforts to
Requirements identify and prosecute money laundering activities involving large-
value funds transfer systems. This support includes maintaining, to the
extent practical, complete originator and beneficiary information when
sending payment orders over any funds transfer system.
Additionally, the Bank Secrecy Act (BSA)’ requires certain

recordkeeping requirements for credit unions engaged in wire transfer
operations on behalf of their members (applies only to transmittals of
$3,000 or more).
The credit union must retain records (originals, copies,

electronically, or on microfilm) for five years; and
0 When the credit union is the originator’s financial institution, it
must retain the following records:
- Name and address of the originator;

- Amount of the payment order;
- Execution date of the payment order;
- Payment instructions received from the originator with the
payment order; and
- Name, address, account number and any other specific
identifier of the beneficiary, if these are received with the
payment order.
NCUA Letter to Credit Unions No. 173, July 1995, contains additional information
about the BSA revision.
Page 9A-18
AUTOMATED CLEARING HOUSE NETWORK =
APPENDIX 9B
Overview The Automated Clearing House (ACH) network electronically
exchanges funds and related information among individuals,
businesses, financial institutions, and government entities. The ACH
Operator provides a central distribution and settlement point for
transmitting funds electronically between an originating depository
financial institution (ODFI) and a receiving depository financial
institution (RDFI.)
The following illustration depicts the ACH Network and their

interrelationships:
How the ACH System Works
RECEIVER 0 RIG INATOR

-company -company
-natural person -natural person
member member
I I
1 ’
I
RDFI
I
J
ACH
OPERATOR
1
1
I
ODFI
I
-credit union -credit union

-bank -bank
Originator. The originator directs a transfer of funds to or from a

receiver’s account by providing the ODFI with payment
instructions. The originator agrees to initiate ACH entries into the
payment system according to an agreement with a receiver. A
company usually acts as the originator (but an individual member
can also originate ACH transactions) directing a transfer of funds
to or from a consumer’s or another company’s account. The term
“company” refers to the originator of electronic ACH entries and
does not imply exclusion of other types of organizations.
Page 9B-1
EXAMINER'S GUIDE
0 Originating Depository Financial Institution (ODFI.) The ODFI

receives the payment instruction from the originator and forwards
the instructions to the ACH operator. A depository financial
institution (DFI) may participate in the ACH Network as a RDFI
without being an ODFI; however, if a DFI chooses to originate
ACH entries as an ODFI, it must also agree to act as an RDFI.
ACH Operator. The ACH operator is a central processing facility

operated by the Federal Reserve Bank or a private sector
organization that (1) receives entries from ODFIs, (2) distributes
entries to appropriate RDFIs, and (3) performs settlement functions
for the affected financial institutions.
0 Receiving Depository Financial Institution (RDFI.) The RDFI

receives ACH entries from the ACH operator and posts them to the
accounts of its depositors (receivers.)
0 Receiver. The receiver is a natural person or organization whose

account is either debited or credited in payment or collection. The
receiver must authorize an originator to initiate an ACH entry to
the receiver's account with the RDFI.
0 Third-Party Processor. Third-party processors are data processing

service bureaus, financial institutions, or other organizations that
provide ACH processing services for financial institutions. A third-
party processor may serve as an agent for an ODFI or RDFI;
however, the ODFI or RDFI remains responsible for compliance
with ACH rules.
Small credit unions and large credit unions approach ACH transactions
differently.
0 Small credit unions usually perform transactions through a third-

party processor. The parties either courier or fax detailed
information back and forth or communicate using modem
communications.
0 Large credit unions usually perform transactions directly on a

FEDLINE terminal that communicates with a Federal Reserve
Page 9B-2
AUTOMATED CLEARING HOUSE NETWORK - APPENDIX 9B
Bank (ACH operator) or uses alternative software to communicate

with a processor.
Data Flow Unlike the wire transfer and check systems, the ACH is both a credit
versus Fund and a debit payment system. ACH credit transactions transfer or
Flow distribute funds from the originator to the receiver, resulting in a
deposit to the receiver’s account. Conversely, ACH debit transactions
transfer or collect h d s from the receiver to the originator resulting in
a withdrawal from a receiver’s account.
Regardless of the funds flow, ACH data flows in the same direction,
from originator to receiver as follows:
1) The originator initiates a debit or credit payment order to the ODFI.

2) The ODFI transmits the payment information to the ACH operator.
3) The ACH operator receives data from the ODFI and sorts the
entries by routing number.
4) The ACH operator transmits the entries to the RDFI.
5 ) The RDFI receives, processes, and posts the ACH data to the
receiver account on settlement day.
ACH The ACH Network supports a number of different payment

Applications applications. A unique Standard Entry Class (SEC) Code identifies
Codes and each application and the related ACH record format used to carry the
Uses payment and payment-related information. An originator initiating
entries into the system codes the entries as either a debit or credit,
which affects either a consumer or a corporate account at the RDFI.
Listed below are SEC Codes and the different products each code
supports.
Consumer 0 Prearranged Payment and Deposit Entries (PPD) include both

Applications Direct Deposits and Direct Payments.
- Direct Deposit is a credit application that transfers funds into a

consumer’s account at the RDFI. These funds represent a
variety of products, such as payroll, interest, pension, etc.
Page 9B-3
EXAMINER'S GUIDE
- Direct Payment (Preauthorized Bill Payment) is a debit

application. Companies with billing operations may participate
in the ACH Network through the electronic transfer (direct
debit) of bill payment entries. Through standing or single entry
written authorizations, the consumer grants the company
authority to initiate periodic charges to their account as bills
become due. Examples of recurring bills paid by ACH include
insurance premiums, mortgage payments, and installment loan
payments. Utility payments represent a non-recurring bill (i.e.,
the amount varies) paid by ACH.
Point of Purchase Entriedshared Network Transactions

(POP/SHR). Two SEC Codes that the consumer most often
initiates via a plastic access card, representing point of sale debit
applications in either a shared or non-shared environment. POP
transactions also include conversion of checks to an ACH debit
application at the point of sale.
0 Machine Transfer Entries (MTE). The Network supports the

clearing of transactions from automated teller machines (ATMs.)
Customer Initiated Entries (CIE). Credit applications where the

consumer initiates the transfer of funds to a company for payment
of funds owed to that company, typically through some type of
home banking product.
0 Telephone Entries (TEL). A single entry debit application initiated

by an originator pursuant to an oral authorization obtained over the
telephone to effect a transfer of funds from an account of the
receiver. This type of entry applies only to a single entry where no
standing authorization exists and originator and receiver have an
existing relationship or, absent the existing relationship, the
receiver initiates the call.
0 Web Entries (WEB). Debit applications initiated by an originator

pursuant to an authorization from the receiver via the Internet to
effect a transfer of funds from an account of the receiver.
Page 9B-4
Corporate 0 Cash Concentration or Disbursement (CCD). A credit or debit

Applications transaction where corporate entities either disburse or collect funds
between themselves. This application can serve as a stand-alone
funds transfer (CCD) or it can support a limited amount of
payment-related data with the funds transfer (CCD+).
0 Corporate Trade Payments (CTP). These allow corporations to

transfer funds (debit or credit) within a trading partner relationship.
0 Corporate Trade Exchanges (CTX). These support the transfer of

funds (debit or credit) within a trading partner relationship in
which a corporation sends full ANSI ASC X12 message or
payment-related UN/EDIFACT information with the funds
transfer.
Other 0 Automated Accounting Advice (ADV). An optional service

Applications provided by ACH operators that identifies automated accounting
advises of ACH accounting information in machine readable
format to facilitate the automation of accounting information for
participating DFIs.
0 Automated Notification of Change or Refused Notification of

Change (COR). An RDFI or ODFI uses this when originating a
notification of change or rehsing notification of change in
automated format. Also, the ACH operator uses it when converting
paper notifications of change to automated format.
0 Death Notification Entries (DNE). Agencies of the federal

government use these to notify a DFI that the recipient of
government benefits has died.
0 Returned Entries (RET). ACH operators that convert paper returns

to automated format use these. ODFIs that originate dishonored
returns also use them when the dishonored return carries the SECC
RET.
0 Truncated Entries (TRC/TRX). These identify batches of truncated

checks.
Page 9B-5
EXAMINER’S GUIDE
0 Destroyed Check Entries (XCK). An institution can use these for

collecting certain checks that were destroyed.
Regulations ACH Rules. National Automated Clearing House Association

That Apply to (NACHA), the governing body for the ACH network, publishes the
ACHs rules annually. The rules incorporate those items approved by the
NACHA members.
User compliance with the ACH rules enables the ACH Network to
operate efficiently. These rules provide warranties and indemnification
addressing origination, receipt, and prompt return of the entries.
Primary responsibility rests with ODFIs for most of the warranties and
indemnifications. However, if the parties enact an agreement
stipulating different responsibilities, many of the ODFI’s
responsibilities can pass through the ODFI to the originator. These
warranties and indemnifications reside with ODFIs and originators
because they have primary control over the initiation of entries.
0 ODFIs must:
- Ensure proper authorization of the entries;

- Submit timely entries into the ACH system;
- Terminate the origination of entries when appropriate;
- Meet the requirements for data security and personal
identification numbers in certain applications, when
appropriate;
- Ensure that the entries contain the appropriate information;
- Assure an agreement is in place with originators and sending
points; and
- Comply with the ACH rules.
The ODFI indemnifies the RDFI, ACH operator, and ACH

association against loss when breaching any of these warranties.
NACHA may require ODFIs that fail to adhere to the ACH rules to
reimburse an RDFI or ACH operator for claims, losses, or
expenses (including attorneys’ fees and costs) that result directly or
indirectly from the breach of warranty. Thus, a failure to comply
with the warranties may result in a loss to an ODFI. While ODFIs
assume responsibility for most warranties related to ACH
Page 9B-6
transactions, the RDFI warrants to each ODFI, ACH operator, and

ACH association that the law permits it to receive entries allowed
by the ACH rules and to comply with the requirements of the rules
concerning RDFIs and participating DFIs.
0 RDFIs must perform the following in a timely manner:
- Receive and validate all ACH entries;

- Post to receiver’s accounts;
- Validate pre-notifications;
- Return entries that do not post within proper timeframes;
- Handle remittance data as receiver requires;
- Make funds available to the receiver within proper timeframes;
and
- Fulfill responsibilities when using a receiving point.
To limit their risk exposure, credit unions must acquire information

and knowledge of ACH rules. They must also comply with the
following applicable regulations:
Electronic Funds Transfer Act (EFTA). Provides for rights and

duties of consumers and financial institutions regarding electronic
funds transfer. EFTA covers transfers initiated by both the private
sector and the government;
0 Regulation E. Issued by the Federal Reserve Board of Governors

implementing EFTA to ensure consumers a minimum level of
protection in disputes arising from electronic funds transfers;
0 UCC-4A. Developed in part for wire transfers, but also applies to

wholesale (institution-to-institution)ACH credit transactions and
certain ACH credit transactions that are not subject to the EFTA.
UCC-4A does not apply to ACH debit or to ACH credit
transactions subject to EFTA; and
Green Book. Published by the Financial Management Services

agency of the Treasury Department. The Green Book specifies
procedures for ACH transactions originated for the Federal
Government.
Page 9B-7
EXAMINER'S GUIDE
Risks to the The amount of risk associated with processing ACH payments varies
Credit Union based on whether the item is an ACH debit or an ACH credit, and
whether the credit union receives or originates the item. Similar risks
exist in the ACH system as those within the wire transfer and check
payment systems.
Credit unions must understand payment processing risks (i.e., credit or

exposure, operational, fraud, systemic, and third-party processing) and
implement detailed written policies and procedures in place to control
them.
Credit The risk that a party to a transaction will not have sufficient funds for
(Exposure) settlement is called credit (exposure) risk. This risk often arises when
Risk one company that is a party to the transaction fails or is bankrupt
before settlement occurs. The examiner must determine that the credit
union limits the risk through necessary controls.
0 ODFI Credit Risks
- ACH Credits. An ODFI incurs temporary exposure to credit

risk for the period of time between the initiation of an ACH
credit file (from one of its originating companies) and the time
when the company funds the account (normally on the
settlement day, which is one to two business days after
initiation.) ACH rules do not allow the ODFI to reverse ACH
credits for failure of the originator to fund its account at the
ODFI. Therefore, the ODFI is financially responsible for one to
two days or until it receives funding from the originator.
During this period of time the ODFI has, in effect, granted an
unsecured short-term loan. Losses could occur if the company
went bankrupt or failed to fund the account between the date of
origination and the date of settlement.
The amount of risk an ODFI assumes is the total amount of the

file not the individual transactions. Therefore, ODFIs must
establish risk control parameters and limits based on the file
totals as well as transaction amounts.
Page 9B-8
If a credit union is an ODFI, it must establish credit monitoring

and control procedures over its members for whom it originates
ACHs (similar to business lending requirements.) Credit union
ODFIs must assign members’ ratings and exposure limits and
must continuously monitor them throughout the various
departments of the credit union.
Requiring pre-funding of the accounts also enables credit

unions to protect themselves. When credit unions take this step,
they are only at risk if the originating company filed for
bankruptcy between the origination date and the settlement
date. In this instance, the funds may become property of the
trustee of the bankruptcy court. Usually, this would merely
delay the credit union’s obtaining final funds. To further
protect themselves, credit unions could require that the
originating party deposit pre-funded amounts on the origination
date into an escrow account in the credit union’s name. This
would reduce the likelihood of a dispute between the
bankruptcy court and the credit union. Examiners should note
that ACH rules do not require pre-funding and credit unions
that require pre-funding could put themselves at a competitive
disadvantage.
- ACH Debits. The ODFI incurs temporary risk from the day the
originating company has the funds available until the RDFI or
the receiver can no longer return the individual ACH debit
entries. An ACH return is an ACH debit or credit that the ACH
operator, receiver, or the RDFI returns to the ODFI. Reasons
for returning ACH debits include insufficient funds, closed
accounts, unauthorized transactions, stop payments, etc.
Return time for ACH debits falls within two general categories:
(1) RDFIs may return non-authorized or revoked authorization
consumer debits up to 60 calendar days after the original
settlement date, and (2) all other returns, which the RDFI’s
operator must receive by its deposit deadline in order to make
the return entry available to the ODFI no later than the opening
of business on the second banking day following the settlement
date of the original entry.
Page 9B-9
EXAMINER’S GUIDE
Normally, the ODFI charges back a returned ACH debit item to

the account of the originating company. However, when
bankruptcy or other legal actions leaves the originator’s
account closed, frozen or with insufficient funds, the ODFI
may suffer a loss for the amount of the returned ACH debit
item. Controlling this risk presents difficulty because an
institution cannot judge whether or not the RDFI and receiver
will have the funds necessary for the transaction to occur.
The amount of risk from originating an ACH debit application

is generally for the amount of returned individual items and not
for the amount of the entire file. Typically, this risk is low,
particularly for consumer ACH debit applications such as
preauthorized debits and point of purchase (POP) transactions.
These consumer transactions generally have small dollar
amounts. However, the consumer’s right of recision under the
ACH rules and Regulation E can cause greater temporary risk.
Examiners should be aware of one exception: the ODFI can
have risk for the entire amount of the originated file for cash
concentration debits.
Credit unions can control the risk of ACH debit returns by

placing holds on a portion of the originator’s account for a
reasonable period of time until the receiver most likely will not
return the items. Additionally, they can require the originator to
place collateral in an account in the credit union’s name.
Ensuring against return of all originated volume would require
holds for up to sixty business days, a rarely encountered
practice. Generally, hold amounts equal a percentage of the
total files and reflect historic return rates for each originator
and application. Credit unions can also control debit return risk
by lowering the exposure limits for the originating company.
0 RDFI Credit Risks
- ACH Credits. The risk to the RDFI in receiving an ACH credit

corresponds directly to the finality granted by its ACH operator
and can vary. If the Federal Reserve serves as the ACH
operator, ACH credits received by an RDFI are final (the point
in time where the Federal Reserve cannot reverse the entry
Page 9B-10
from the RDFI’s reserve account) after the close of business on

settlement day. The Federal Reserve interprets finality for ACH
credits as when the credit union posts the transactions to its
reserve account, which can be as late as just prior to the
opening of business on the day following settlement.
If the ODFI fails before or during the day of settlement, the

Federal Reserve may reverse ACH credit transactions
originated by the ODFI and settling on that day. Usually, when
the RDFI receives credits, the Federal Reserve credits the
receiver’s account on the settlement day leaving the credit
union open to risk if the ODFI fails and the Federal Reserve
reverses the entries. The RDFI’s exposure extends only to the
amount of funds it made available before settlement is final. If
it reverses the transaction, the RDFI will debit the member’s
account that it previously had credited. The RDFI runs the risk
that the receiver’s bankruptcy or failure will prevent it from
recovering these funds.
RDFIs face operational risks related to ACH credits. Most

liability centers on promptly posting the credits. RDFIs may
expose themselves to legal costs and civil penalties when they
fail to comply with these posting deadlines. Therefore, credit
unions acting as RDFIs must comply with the rules governing
ACH transactions.
- ACH Debits. The RDFI’s operational risk in processing ACH

debits lies in deciding whether or not to return an ACH debit by
its ACH operator’s deposit deadline, so the ODFI has the return
entry available no later than the opening of business on the
second banking day following the settlement date of the
original entry. However, deadlines for unauthorized debits, and
instances where authorization has been revoked, allow up to
sixty days for a return. RDFIs that fail to meet these return
timeframes may experience a loss if the ODFI dishonors the
return as untimely.
Credit unions can control this risk by automatically returning

ACH transactions for insufficient funds. However, some credit
unions may choose to assume some credit risk in processing
Page 9B-11
EXAMINER’S GUIDE
ACH debits by allowing an ACH debit to post, even if it

overdraws the receiver’s account. While some credit unions
may allow this as a common practice (similar to allowing
members to overdraw their checking accounts), the examiner
should determine whether or not the credit union has
implemented adequate controls and monitoring procedures.
Operationa Risk Operational risk, which varies with the type of processing, is the
danger that an unintentional error will alter or delay a transaction.
Examiners should determine that the credit union has implemented
necessary controls to limit this risk. Following are examples of
operational risks and the necessary controls that credit unions must
have in place to protect against them:
0 Hardware failure. Management reduces this risk through reliable

equipment, regular maintenance, responsive service personnel, and
adequate backup (including addressing hardware substitution or
replacement in the credit union’s disaster recovery plan.)
0 Software failure. Management limits this risk by adequately testing

the vendor’s or service provider’s software before relying on it for
processing. Credit unions that develop their own software can
reduce the risk of disruption due to software problems with sound
software development practices (e.g., adequate documentation,
sound testing procedures, tight change control procedures, effective
recovery facilities, and periodic internal and external audits.)
0 Data loss. Management can reduce this risk by implementing the

following controls:
- Storing data securely. Management must protect electronic files

against unauthorized or inadvertent change by using file
security techniques and must keep hard copy records in locked
storage;
- Limiting access to data to authorized personnel;
- Duplicating, backing up, and storing data offsite to protect
against data loss or destruction;
- Establishing and maintaining audit trails of all transactions and
changes;
~ ~
Page 9B-12
- Accounting for all files to ensure that staff (1) only processes
current files, and (2) does not inadvertently duplicate or omit a
file from processing; and
- Balancing file totals during processing to ensure that staff does
not drop, change, or duplicate transactions.
0 Telecommunications failure. Management can limit this risk by (1)

maintaining telecommunications equipment (lines, modems,
authentication or encryption devices, etc.) in working order; (2)
physically protecting the equipment; and (3) developing diagnostic
tools and backup modes of transmission in the event of a problem.
Power failure. Management can reduce this risk by obtaining an

uninterruptible power supply system to remove spikes and
transients from public power and provide auxiliary power during a
blackout. Additionally, management should arrange for a generator
to handle longer-term power failures.
0 Human error. Management can reduce this risk through (1) good
supervision, (2) detailed operating procedures, (3) effective
training, (4)periodic internal and external audits, (5) monitoring
file and dollar controls, and (6) adequate audit trails.
0 Staffing problems. Management can reduce the risk of problems

resulting from absences, turnover, work stoppages, etc., which vary
with the size of the credit union, by emphasizing cross training and
good supervision. Staffing problems in small credit unions often
result from only one or two people knowing the process. In very
large credit unions, the specialized nature of each activity enables
few people to know the overall process.
0 Natural disasters. Management cannot control this broad category

of operational risk, which includes disasters such as earthquake,
flood, and fire. However, management must develop and test
disaster recovery plans to identify alternate modes of operations
and alternate operating sites and to ensure that operations will
continue should a disaster occur.
Page 9B-13
EXAMINER'S GUIDE
Fraud Risk Fraud risk is the danger that an employee or interlopers who gain
unauthorized access to the system will initiate or alter a payment
transaction in an attempt to misdirect or misappropriate funds.
Examiners should review for adequacy the credit union's controls,

which should include the following:
0 Personnel practices. Management must write personnel policies

that enhance internal controls within the ACH operation.
0 Physical security. Management must (1) limit access to computer

and communications equipment sites to authorized personnel, (2)
protect sensitive equipment within the secured area using access
controls or device locks, and (3) secure and limit access to all data
on portable media (tapes, disks, hard copies, microfiche, etc.)
0 Data security and integrity. Management should (1) purchase

commercially available software products to access production data
files; (2) limit access to specified programs or user IDS by setting
up each file for read-only or read-and-write access; and (3) employ
encryption, authentication, and dial back data protection techniques
when accessing data-in-transit from one participant to another.
Both the encryption and authentication require the use of a key,

which may reside on a hardware component such as a circuit card
or may be a data element that authorized personnel enters into a
security program or system. The assignment, distribution, and
control of encryption or authentication keys represent important
data security controls.
0 Software and data changes controls. Management must maintain

detailed written development and change policies.
0 Access restriction. Management must restrict access on software

products using (1) operator passwords to prohibit entry by
unauthorized personnel; (2) automatic features to control the
number of unsuccessful password attempts, password expiration,
or designated periods of inactivity; (3) multilevel functions by
password to require dual control and ensure that no single
employee can create and send transactions (e.g., restricting one
Page 9B-14
operator to file creation and a second operator to file approval or

transmission); and (4) system administration level procedures that
require secondary approval to assign, initiate, and maintain
passwords.
0 Processing dollar and file limit controls. Management must require

use and enforcement of exposure limits (1) at the time of entry,
batch, or file creation; (2) at the time of transmission; or (3) both
(1) and (2.)
0 Operational controls. Management must require procedures to

implement the following operational controls:
- File controls to ensure that staff (1) accounts for all files at each
step in ACH processing, (2) only processes current files, and
(3) does not accidentally or intentionally duplicate or omit files
from processing;
- Dollar controls to (1) confirm dollar totals at each step in ACH

processing, and (2) help ensure in-balance ACH files,
accurately posted accounts, and properly settled ACHs;
- Date controls (file creation date, effective entry date, and

settlement date) to monitor that staff processes the files within
the time frames established by the various regulations;
- Exception reporting to monitor (1) circumstances such as over-

limit activity, (2) anticipated files not received, and (3) file
inconsistencies that may suggest error, intrusion, or
duplication;
- Audit trails including procedures to (1) maintain a record of all

ACH transaction data and all changes to static data, (2) respond
to member inquiries, (3) reconstruct a sequence of events if a
problem occurs, and (4) comply with NACHA rules;
- Reconciliation of the actual entries on the Federal Reserve

Statement of Account or similar statement from a
correspondent financial institution to verify that the ACH work
settled as anticipated. Proper segregation of duties requires that
Page 9B-15
EXAMINER’S GUIDE
the staff member responsible for reconciling ACH transactions

should not be otherwise involved in the ACH processing; and
- Internal audits of the ACH process. NACHA rules require each

financial institution to complete an internal audit of its ACH
operations at least once every year (a copy of which the credit
union must retain on file.) Completion of the audit by all
financial institutions reinforces compliance with the ACH rules
and improves the overall quality of the ACH network.
Systemic Risk Systemic risk is the danger that the inability of one funds transfer
system participant to settle its commitments prevents other participants
from settling their commitments. Systemic risk is closely related to
credit risk. While a fraudulent or erroneous transaction could
constitute a source of systemic risk, a participant’s failure would more
likely trigger a major settlement failure.
The likelihood of systemic risk varies greatly among payment systems.

A connection exists between the dollar volumes a network handles and
the systemic risk involved: the greater the number of high dollar
payments a network processes, the greater the systemic risk, and the
greater the need for elaborate risk controls.
A small threat of systemic risk relates to ACH transactions, because a

far less average dollar value exists for ACH transactions than for
FEDWIRE or CHIPS. Rarely does a financial institution’s position
with respect to gross ACH settlement approach its capital level. A
financial institution’s position on the FEDWIRE or CHIPS network
will more likely exceed its capital.
Third-Party Risk Third-party processors include data processing service bureaus,

financial institutions, or other organizations that provide ACH
processing services for credit unions. Examiners should understand the
risks and concerns present when a credit union uses a third-party
processor and should determine that the credit union has current,
detailed agreements in place that fix responsibility and accountability
between the parties. Third-party risks are as follows:
Page 9B-16
Allowing a corporate member to send files directly to the ACH

operator. A credit union, acting as an ODFI, that allows a corporate
member (originator) direct access to its ACH operator exposes
itself to credit, fraud, and operational risk. The credit union
warrants the validity of the transactions sight unseen and bears
ultimate responsibility for the transactions. If the corporation fails
or transmits fraudulent or erroneous entries, the credit union bears
responsibility for the corporation’s actions.
Using a correspondent DFI for processing and/or settlement. A

correspondent bank or corporate credit union provides processing
and/or settlement services to the credit union acting as an ODFI.
This situation exposes the credit union to credit, operational, and
fraud risk because the correspondent could make a mistake or fail
to process or settle its transactions.
0 Using a correspondent DFI or data processing organization for

ACH processing only (not settlement.) A credit union acting as an
ODFI is exposed only to the risk that the third party will make a
mistake or error. In this situation, the credit union faces only fraud
and operational risk with respect to the third-party processor.
ACH Risk NACHA publishes a comprehensive guide called the ACH Risk
Management Management Handbook,which further details the ACH risk issues and
Handbook control procedures discussed in this appendix. Additionally, NACHA
and Self- publishes a self-audit survival guide for financial institutions that
Audit anticipate conducting or have conducted audits of its compliance with
Survival the ACH operating rules. These required annual audits assist the credit
Guide union in assessing its risk regarding its wire transfer activities and
compliance responsibilities. The examiner should ask the credit union
if it has completed this audit and if it has obtained the results of each
third-party processor’s annual ACH self-audit. The credit union can
obtain both publications by writing or calling NACHA at National
Automated Clearing House Association, 607 Herndon Parkway, Suite
200, Herndon, Virginia 22070, telephone: (703) 742-9190.
Page 9B-17
ITEM PROCESSING APPENDIX 9C -
Overview Item processing is the internal processing of share drafts or checks by
the credit union. The three basic types of item processing are in-
clearings, transit items, and inter-clearing arrangements, defined
below. Item processing results in settlement (payment or collection)
through the Federal Reserve Bank (FRB) or a correspondent bank and
posting of transactions to the member’s account. Many larger credit
unions are developing in-house item processing to reduce the costs of
external check processing. Services are also available in corporate
credit unions, credit union service organizations (CUSOs), banks, and
national or regional check-processing service centers.
Third-Party Many third-party institutions have a contractual arrangement with the

Item credit union whereby the credit union pre-funds processing activities
Processing by placing and maintaining a deposit at the institution. The required
deposit relates to the credit union’s average daily processing activity
and, though it varies from institution to institution, may represent a
substantial portion of the credit union’s assets. When the deposit
exceeds the insured limit (if applicable), the credit union is at risk for
this excess in the event that the third-party institution fails.
Credit unions using third-party institutions for item processing must

institute policies and procedures to minimize the potential risk of loss.
Additionally, credit unions must exercise due diligence, both before
entering into a contract with a third-party institution and periodically
thereafter. At a minimum, credit unions should:
0 Contact several processors. By reviewing the financial statements,

the most recent audit report, and other pertinent reports or
correspondence, the credit union can assess the financial condition
of each institution before entering into a contract.
0 Review contract terms and conditions. The credit union and its
legal counsel should carefully review the terms and conditions of
each institution’s contract.
Page 9C-1
EXAMINER'S GUIDE
0 Assess periodically the financial condition of the institution. On an

ongoing basis, credit unions should review the institution's
financial statements, peer group ratios and rankings, and audit
reports at least annually, paying particular attention to capital and
profitability ratios.
Change processors, if necessary. If the financial stability of the

institution becomes questionable, the credit union should consider
changing to another institution. The credit union must consider
issues such as the cost of changing processors and the terms of the
contract. Credit unions can considerably reduce the cost of
changing processors if they use their own routing and transit
number on share drafts (payable-at method) rather than using the
routing and transit number of the payable-through bank (payable-
through method.) Credit unions using their own routing and transit
number need not reissue new share drafts if they change
processors. Before selecting the payable-at method, officials should
discuss this option with individual processors. The terms,
conditions, and level of credit union responsibility for a routing
and transit program vary from processor to processor.
Share Draft Some credit unions process their own checks. After a member writes a
In-Clearings share draft to pay a bill, the merchant or vendor deposits the share draft
in the local bank. The bank encodes (with the bank's routing and transit
number on the drafts) the deposit and sends the share draft to the FRB.
The FRB processes the draft, credits the local bank's account, and
charges the credit union's account. The FRB then sends the share drafts
to the credit union by courier.
The credit union sorts and microfilms the drafts and posts the in-
clearings to the members' draft accounts. The next morning, a share
draft exception report identifies accounts with insufficient funds. The
credit union pulls returns and sends them to the FRB for return to the
local bank. The bank charges the vendor's account.
Deposit Some credit unions process in-house check deposits for credit to
Processing members' accounts. The credit union takes the day's deposits, encodes
the checks with the credit union's routing and transit number,
Page 9C-2
ITEM PROCESSING - APPENDIX 9C
processes them, and sends them to the FRB for credit to the credit
union's account.
Local Clearing A group of banks or other financial institutions in a defined geo-

House graphical area may form a local clearing association to directly process
Arrangements their checks.
A member writes a share draft and the payee deposits it at the local
bank. After processing, the local bank sends the checks and a cash
letter by courier directly to the credit union. The credit union processes
the checks, confirms the payment amounts on the cash letter, and posts
the amounts to the members' share draft accounts. The credit union
then pays the local bank (usually by FEDLINE wire).
The credit union then sorts the members' local checks deposited at the
credit union according to bank, and sends each participating bank a
cash letter and a bundle of checks issued by that bank with a demand
for payment. The bank processes the checks and wires settlement to
the credit union.
Examination Item processing involves substantial risk. Deficiencies in the internal

Concerns controls, such as failure to process items promptly or correctly, could
result in significant losses.
When examining credit unions involved in item processing, the

examiner should (1) evaluate management control of operations, (2)
determine the risks to the credit union, and (3) ensure that the credit
union has instituted policies and procedures to minimize the potential
risk of loss. Individual item processing operations will vary; however,
all operations require necessary management and internal controls.
The examiner should develop an understanding of the credit union's

item processing operation. At a minimum, the examiner should review
policies and procedures and understand the flow of items through the
entire system. This understanding comes through discussions with
management and system demonstrations. The examiner should also
determine that the credit union accurately and promptly posts all
Page 9C-3
EXAMINER'S GUIDE
general ledger accounts used in the process and promptly clears

exceptions.
If deficiencies exist, the examiner should expand the scope of the

review (after obtaining the supervisory examiner's concurrence),
which may require additional examiner staff with item processing
expertise.
Business Before establishing an item processing operation, credit union

Plan, Budget, management must develop a business plan, including a budget that
cost identifies the item processing services offered, and the resources
Analysis, and needed to support the service. After developing and analyzing the
Profitability business plan, the credit union may find that it cannot afford to
maintain an item processing operation. The business plan requires
periodic revision once the item processing department is operational.
The business plan should document:
The costs and revenue projections associated with an item

processing department and the accounting system used;
The overall effect of the processing operation on the credit union's
financial performance;
0 Identified risks and internal controls necessary to manage those
risks;
0 Department structure including staffing and management needs;
System configurations including hardware and software needs;
0 Training, both initial and on-going, for management and staff; and
0 Disaster recovery, including testing.
Equipment An item processing operation requires a significant investment in

and Software hardware and software. A sorter performs sorting, microfilming or
Requirements imaging, return pulling, data accumulation, and data transmission
functions.
A credit union that processes its own checks transmits applicable data
to its own information processing system for posting to its members'
accounts. A credit union that processes for other credit unions
establishes systems to electronically transmit the data to the other
credit unions' computer systems for posting.
Page 9C-4
Other equipment needed includes rejectlreentry stations, encoding

stations, correspondence desks (positions for resolving and researching
differences), check storage areas onsite and offsite, microfilming
duplicating services, microfilm machines, and computer terminals.
The credit union must maintain adequate physical access controls and
segregation for the item processing equipment, computer controller,
storage areas, and different work areas. Climatic controls, fire control
equipment, and security controls are examples of other hardware
needed.
Staffing An item processing operation requires staff with specific experience

and training in item processing. Often credit unions recruit staff from
the larger banks, corporate credit unions, and service centers.
Sufficient internal controls, adequate separation of duties, and
corresponding authority on the computer are important for operations
of all sizes.
Microfilming Item processing operations rely heavily on microfilm or electronic

and Data imaging. Cash letter differences, other adjustments, and disputes (from
Backup members, banks, or FRB) require the evidence that microfilming or
imaging provides. The credit union must have controls in place to
safeguard the microfilm or image files and ensure readability. The
credit union must backup processing data from the sorter and
controller daily and must maintain adequate generations both onsite
and offsite. (Credit unions must maintain at least two full copies of the
microfilm or image files offsite.)
Policies and Sound policies control item processing risks, operations, and
Procedures management. Management must review operations to ensure
compliance with policy.
Management must also develop detailed procedures for all item

processing positions. These procedures should document required
functions, deadlines, internal control steps, and policy requirements.
Page 9C-5
EXAMINER'S GUIDE
The board should establish a write-off policy. Management can

authorize staff to write off small differences (e.g., those under $1.)
Larger write offs should require documentation supporting the write
off and management authorization.
Internal Management must establish internal controls for item processing that
Control and include adequate separation of duties, active account reconciliation,
Review of and prompt clearing of differences.
0perations
The following duties must be separated: reject reentry, return
processing, correspondent services (research and clearing of
adjustments and differences), Federal Reserve account reconcilements,
cash balance management, and review of documentation supporting
reconciliation and clearing differences. Cash letter totals must
reconcile to transmission totals, and staff must identify and promptly
clear any differences.
An independent staff member should review documentation for

adjustments of uncleared items. Management should closely control
and separate return processing and reject reentry functions from the
check processing function. Additionally, staff must reconcile both
transmission totals (electronic posting to member accounts) and
reconcilement of processing and transmission totals to the FRB
account daily.
The item processing operation could involve three computer systems:

(1) check processor, ( 2 ) general ledger and share and loan trial balance
system, and (3) the computer that interfaces the check processor with
the general ledger and share and loan trial balance system. The internal
control plan must correspond to the plan for appropriate segregation of
duties.
Internal The review of accounting should begin after the examiner obtains a
Cont roI basic understanding of how the system processes, posts, and settles
Review of transactions. After performing a test of the FRB account reconciliation
Accounting and all clearing and suspense accounts, the examiner should then trace
all reconciling items for the period tested through to clearing on the
statement or to independent source documents.
Page 9C-6
Legal The examiner should review the legal agreements established by the
Agreements credit union in the following areas:
Line-of-credit agreements for credit unions that process checks and

deposits for other credit unions, transmit posting data to other
credit unions, and receive debits or credits at their FRB (or
correspondent bank) on their routing and transit number.
Settlement lines of credit cover check clearing settlement if the
other credit union's account balance is insufficient to cover
clearings;
A disaster recovery plan that includes agreements for alternate site
processing and equipment use;
Vendor agreements outlining responsibility for software and
hardware maintenance and support;
Agreements with the FRB (or other correspondent bank) and
hardware and communication vendors for funds settlement and
electronic transmission activity; and
Any other material agreements needed to support the item
processing operation.
Disaster The examiner should review management's disaster recovery plan to

Recovery ensure that it enables the credit union to recover from difficulties that
Plan could interrupt the item processing operation. Recovery systems
should include:
0 Staff knowledge about the disaster recovery plan;

0 An alternate processing location;
0 Offsite maintenance of a copy of the disaster recovery plan;
0 Duplicate equipment, either purchased or rented, sufficient to
operate the item processing center; and
0 A regular review process of the disaster recovery plan to ensure the
plan is current and viable.
The credit union should perform full periodic testing of the disaster
recovery plan as it relates to the item processing operation originating
from alternate site equipment and different system configurations.
Page 9C-7
4c-274 3 4 - L
Chapter 10
LOANS
TABLE OF CONTENTS
PART I LOANS .GENERAL LOAN REVIEW ........................................................... 10/1-1

Examination Objectives ....................................................................................... 10/1-1
Associated Risks .................................................................................................. 1O/1. 1
Overview.............................................................................................................. 10/1-3
. . Guidelines
Examination . . ....................................................................................... 10/1-3
Loan Documents .................................................................................................. 10/1-5
Loan Exceptions.................................................................................................. .lo/ 1.5
Impermissible Loans ............................................................................................ 10/1-6
Loan Programs and Policies ................................................................................. 1O/l -6
Lending Practices ................................................................................................. 10/1-9
Credit Report Analysis............................................................................. 10/1-10
Capacity to Repay .................................................................................... 10/1-1 1
Credit Scoring .......................................................................................... 1O/1.
1 1
Paperless Lending ................................................................................................ 10/1. 13
Examiner Guidance..................................................................................lO/ 1-13
Risk-Based Lending .............................................................................................lO/ 1-14
Large Loans and Concentrations.......................................................................... 10/1- 15
AIRES .................................................................................................................. 10/1-15
Workpapers and References................................................................................. 1O/1-16
PART 2 LOANS - CREDIT RISK, DELINQUENCY, & CHARGE OFFS ...................10/2-1
Associated Risks .................................................................................................. 10/2- 1
Overview.............................................................................................................. 1012-1
Evaluating Credit Risk ......................................................................................... 1O/ 2-1
Delinquency Control ............................................................................................ 10/2-3
Collection Procedures .......................................................................................... 10/2-5
Extension and Refinancing ...................................................................... 1O/
2-7
Credit Card Collection Program .............................................................. 1012-8
B d p t c y ........................................................................................................... 10/2-8
Forms of Bankruptcy Relief ..................................................................... 10/2-8
Automatic Stay......................................................................................... 10/2-10
Discharge - Objections and Exceptions ................................................... 10/2-10
Reaffirmation ........................................................................................... 10/2-12
Transfers Not Promptly Perfected or Recorded ................................................... 1O/2- 12
Statutory Lien .......................................................................................................lO/ 2-12
Loan Loss Ratio (Net Charge Offs to Average Loans) ............................ 1O/ 2- 13
q c-9
EXAMINER'S GUIDE
PART 2 LOANS .CREDIT RISK. DELINQUENCY. & CHARGE OFFS

Continued
Charge Off of Problem Credits ............................................................................ 10/2. 14
Collateral in Process of Liquidation......................................................... 10/2. 16
Other Real Estate Owned (OREO) .......................................................... 10/2-16
Accounting for OREO ............................................................................. 10/2. 17
Workpapers and References................................................................................. 1O/ 2.
1 7
APPENDIX 1OA - LOAN TYPES .................................................................................. 1OA- 1
Loans to Insiders .................................................................................................. 1OA- 1
Co-makers and Co-signers ................................................................................... 10A-1
Policies and Procedures ........................................................................... 10a-2
Lines of Credit ..................................................................................................... 10a-3
Internal Controls for Plastic Cards ........................................................... 10a-4
Monitoring Lines of Credit ...................................................................... 10a-5
Open-End Loans .................................................................................................. 10a-5
Variable Rate Loans ............................................................................................. 10a-5
Guaranteed Student Loans ................................................................................... 10a-7
Due Diligence on Student Loans ............................................................. 10a-7
Real Estate Loans ................................................................................................. 10a-8
The Secondary Market ............................................................................. 10a-9
Appraisals ................................................................................................ 1OA-1 0
Evaluating Appraisers .............................................................................. 1OA-1 1
Holding versus Selling Loans .................................................................. 1OA-1 1
Servicing Mortgage Loans ....................................................................... 1OA-1 2
Servicing Rights: Sell or Keep ................................................................. 1OA-1 2
Selling of Servicing Rights ...................................................................... 1OA-1 2
Escrow Accounts ..................................................................................... 10A-15
Foreclosures ............................................................................................. 1OA-15
Internal Controls, Segregation of Duties.................................................. 10a-16
Independent Quality Control.................................................................... 1OA-1 6
Asset/Liability Management .................................................................... 1OA-1 6
Adjustable Real Estate Loans .................................................................. 1OA-
1 7
Subordinate (Second) Mortgages............................................................. 1OA-17
Home Equity Lines of Credit ................................................................... 1OA-
1 8
Loans Secured by Mobile Homes and Real Estate .................................. 1OA-20
Insured - Guaranteed Loans..................................................................... 1OA-20
Auto-Equity Loans ................................................................................... 10a-2 1
Construction Loans .............................................................................................. 10a-2 1
Land Loans ........................................................................................................... 1OA-23
Member Business Loans ...................................................................................... 10a-23
Underwriting ............................................................................................ 10a-24
Documentation......................................................................................... 10a-26
Environmental Protection Agency (EPA) Concerns................................ 10a-27
Types of Member Business Loans ........................................................... 1OA-28
LOANS
APPENDIX 1OA . LOAN TYPES Continued

Rental Property Loans .............................................................................. 1OA-28
Working Capital Loans ............................................................................ 10a-28
Term Business Loans ............................................................................... 1OA-30
Agricultural Loans ................................................................................... 10a-30
Letters of Credit ....................................................................................... 10a-3 1
Floor Plan Loans ...................................................................................... 1OA-32
Examination Guidance............................................................................. 10a-33
SBA LOUIS........................................................................................................... 10a-34
Participation Loans .............................................................................................. 10a-34
Purchase, Sale and Pledge of Eligible Obligations .............................................. 10a-35
Stock Secured Loans ............................................................................................ 1OA-35
Loan Policy and Procedure ...................................................................... 10a-36
Required Documents................................................................................ 10a-37
NCUA Guaranteed Loans .................................................................................... 10a-38
Indirect Dealer Financing Programs .................................................................... 10a-39
Potential Problems ................................................................................... 10a-41
Warning Signs.......................................................................................... 10a-43
Regulatory Issues ..................................................................................... 10a-43
Direct vs. Indirect Point of Sale Programs............................................... 10a-44
Leasing ................................................................................................................. 10a-45
Residual Value Insurance ......................................................................... 10a-46
Auto Insurance ......................................................................................... 10a-46
Regulation “M’ ........................................................................................ 10a-46
Income on Leases ..................................................................................... 10a-48
Leasing Program Problems ......................................................................lO A-49
Balloon Notes ....................................................................................................... 10a-5 1
Boat Loans ........................................................................................................... 10a-5 1
APPENDIX 10B - Glossary of Loan Terms ................................................................... 10B-1
APPENDIX 1OC - Member Business Loan Financial Ratios ......................................... 1OC- 1
APPENDIX 1OD - Sample IDFP Agreements ................................................................ 1OD- 1
APPENDIX 1OE - Real Estate Documentation Checklist............................................... 1OE- 1
Chapter I 0 - Part 1
LOANS - GENERAL LOAN REVIEW

Examination Evaluate management’s ability to identify and manage risk
Objectives Evaluate the quality of the loan portfolio and the extent of related
risks in lending activities
Evaluate whether management has established adequate lending
standards and maintains proper controls over the program
Determine whether management adequately plans for all lending
programs, committing the necessary resources in terms of
technology and skilled personnel
Assess whether the credit union has the financial capacity to
conduct lending safely, without undue concentration of credit and
without overextending capital resources
Analyze the loan portfolio’s performance, including profitability,
delinquency, and losses
Consider management’s response to adverse performance trends,
such as higher than expected delinquencies, charge-offs, and
expenses
Determine if the credit union’s compliance program effectively
manages the fair lending and consumer protection compliance risks
Determine whether management has implemented an effective
internal loan grading system (if applicable) to identify credit risk
Associated Credit risk. Credit risk, which involves the ability of the member to
Risks repay the obligation, affects all types of loans. Loans with a
guarantee (student, VA, SBA, FHA, NCUA purchase) contain a
lesser degree of credit risk.
Compliance risk. Each loan type has various degrees of compliance

risk. Various NCUA regulations, state laws, and federal consumer
compliance laws apply to both consumer loans and real estate
loans. Failure to comply with these laws and regulations exposes
the credit union to fines, civil money penalties, and diminished
reputation.
Page 1011-1
EXAMINER’S GUIDE
0 Interest rate risk. Interest rate risk increases as the terms of the
loans extend. Monitoring this risk involves a large segment of a
credit union’s asset-liability management (ALM) program. Credit
unions engaging in real estate lending should recognize that
changes in interest rates affect the fair value of their balance sheet.
Variable-rate loans also can experience interest rate risk since they
may contain lifetime and periodic “caps” that limit the credit
union’s ability to increase (reprice) loan rates.
0 Strategic risk. Strategic risk appears in the diversification of loans

offered to members. Management’s due diligence in the planning
effort before implementing new loan programs will greatly affect
the amount of this risk. A well-established program should have
less risk than a proposed or newly instituted program.
0 Transaction risk. Numerous transaction risks accompany lending.

The strength of the credit union’s internal controls will determine
the extent of the risk. Management may demonstrate their control
of transaction risk through reviewing internal reports such as Paid
Ahead Loans, Non-Amortizing Loans, File Maintenance,
Supervisory Override, Accrued Interest Greater than Payment, etc.
Appendix 4B to the Internal Controls chapter of this Guide
discusses other specific loan-related reports.
0 Liquidity risk. The success of any lending program determines the

level and type of liquidity risk involved. Credit unions engaging in
real estate lending should evaluate and understand the variability of
mortgage cash flows and the corresponding effect on its balance
sheet. When interest rates fall, mortgage cash flows increase;
conversely, when interest rates rise, mortgage cash flows decrease.
This could result in a credit union having either too much or too
little liquidity. To control liquidity risk, management must
understand the interrelationships of interest rates, mortgage cash
flows, prepayment risk, extension risk, and the effect on the fair
value of its assets.
0 Reputation risk. Lending and the types of loan programs offered

greatly affect reputation risk. Collection efforts, or lack of them,
influence the members’ perception of the credit union, as do
lending personnel and how they deal with the public. If the credit
Page 1011-2
union has an indirect dealer loan program, the reputation of the

dealer can affect the reputation of the credit union and the program.
Overview A credit union usually derives its primary source of income, as well as
a major source of risk to its solvency, from its loan portfolio.
Therefore, credit unions support this major asset account with sound
business planning, policies, and internal controls.
Examination Examiners should try to obtain either an AIRES loan download or an

Guidelines ASCII formatted download file. Examiners should use their best
judgment in considering whether, and to what extent, to review a
particular portfolio. When examiners identify material concerns during
the scope process, they should expand procedures to identify the cause
of the problems, determine the severity of the noted problems, and
devise plans for corrective action.
If examiners determine the analysis of the risk areas noted in the Scope
Workbook warrants a loan review, they can use the AIRES Loan
Review or a self-designed workpaper to document their review. The
loan review may include any or all of the following, based on the
examiner’s judgment:
Charged off loans. Examiners should scan the charged off list for
unusual activity and review basic internal controls (board approval,
proper accounting, assignment to a collection agency, etc.) They
may expand their scope to review individual loans charged off to
determine the extent of the problem and to develop plans for
resolution. Examiners should encourage the credit union to
perform an ongoing analysis of charged off loans to determine
common characteristics, or loss trends by loan type for ALLL
analysis.
0 Delinquent loans. Examiners should scan the delinquent loan list

for unusual activity and review basic internal controls (consistent
and timely collection efforts and charge off.) Reviewing larger and
more recently granted loans may prove beneficial in correlating
underlying problems of the delinquent loans with those of the
current loan portfolio. Examiners should consider reviewing loans
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EXAMINER'S GUIDE
that were seriously delinquent at the previous examination to

assess their disposition.
Current loans. Examiners should select a random sample of current

loans to review for adherence to policies and regulations, as well as
documentation, and underwriting quality.
Insider loans. Examiners may select a sample of loans made since

the last examination to officials, credit union employees, and their
immediate family members.
Large loans and concentrations of credit. Examiners should select

samples of large loans and concentrations of credit. In a credit
union with numerous routine mortgage loans, examiners may
review a sample of non-routine large loans.
Member business loans and construction loans. Examiners should

select samples of member business and construction loans.
Examiners should document the status of the member business
loan portfolio if the member business loans exceed the regulatory
limits of $723.16 of the NCUA Rules and Regulations, the credit
union has received an exception from these regulatory limits
($723.17), or the credit union has received a waiver for a category
of loans ($723.10.)
Other loan categories. Examiners may select a sample of loans

from the following categories, if they exist:
New programs Line of credit

Real estate Home equity
Insured-Guaranteed Credit card
Participation Agricultural
Floor plan Paid-ahead
Open end SBA
Risk-based Lease
Non-amortizing loans Repossessions
Foreclosures Paperless loan systems
Indirect dealer financing program
With an AIRES download, examiners can use standard or customized

loan queries to pull specific loans meeting defined characteristics.
Page 1011-4
Part 2 of this chapter discusses delinquent loan control. Appendix 1OA

discusses the various loan types. Appendix 1OB contains a glossary of
loan terms and Appendix 1OC contains specific financial ratios to
analyze member business loans. Appendix 1OD contains sample
Indirect Dealer Financing Program (IDFP) agreements. Appendix 1OE
contains a documentation checklist for real estate loans.
Loan Credit unions must require adequate loan documentation for all loans.
Documents Weak documentation practices could adversely affect the ability to
successfully collect the loans in a litigation action, and could lower the
value of loans in merging or liquidating credit unions.
Adequate loan documentation includes the following:
0 A completed loan application along with documented approval;

0 Documented creditworthiness analysis including:
- Verification of income;
- Credit reports; and,
- Debt ratio or disposable income analysis;
0 Evidence of collateral value (e.g., purchase invoice, appraisals);
0 Loan officer worksheets and notes;
0 A completed note or security agreement; and
0 A perfected collateral lien and adequate insurance.
Loan Through a review of the individual loan files, the examiner identifies
Exceptions as loan exceptions (1) documentation deficiencies, (2) loan processing
exceptions, (3) violations of the FCUAct or NCUA Rules and
Regulations, ( 4 ) violations of the credit union's lending policies, ( 5 )
violations of consumer compliance regulations, and ( 6 ) deficient credit
practices. Examiners may use AIRES Loan Exceptions, or a self-
designed workpaper, to detail their exception comments on the loan
review.
When loans are missing from the files, and staff cannot locate the
documents, examiners should provide the supervisory committee with
a list of missing loans. Examiners should obtain an agreement that the
supervisory committee will promptly contact the borrowers to confirm
the loan's authenticity.
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EXAMINER'S GUIDE
Examiners should treat chronic loan documentation and loan quality

problems (e.g., the lack of establishing the creditworthiness of
borrowers, recording titles, liens, UCC filings, obtaining real estate
appraisals, verifying income, etc.) as a major area of concern.
Impermis- Loans made in violation of the FCUAct or NCUA Rules and

sible Loans Regulations are impermissible. Examiners should document these
violations as loan exceptions, provide guidance to the officials
regarding their responsibilities in connection with the violations, and
make appropriate recommendations for corrective action. When
examiners review only a portion of the loans, they should instruct the
officials to review all similar loans for possible violations.
If the credit union made intentional or material impermissible loan

disbursements, the board of directors must notify surety and request
assurance that bond coverage will continue. The credit union must call
the impermissible loan disbursement, unless the credit union made the
loan to a "good faith" borrower. Since credit unions cannot legally
compel good faith borrowers to return the money in terms other than
those found in the original loan agreement, the credit union must honor
the terms of the loan. If the credit union does not renegotiate or correct
the loan and a loss occurs, the credit union should file a bond claim
with surety for the balance of the impermissible disbursement.
The supervisory committee should determine the board has taken

appropriate action to address impermissible loans and to file a claim or
protect the right to file a claim with the surety company. The examiner
should make certain the committee members, as well as directors and
appropriate employees, familiarize themselves with their exact duties
regarding impermissible loans.
Loan Section 701.2 1(c)(2) of the NCUA Rules and Regulations and sound
Programs business practices require that credit unions develop written loan
and Policies policies. The following financial considerations apply:
Member needs. Each credit union serves a different field of

membership with somewhat differing needs. Credit unions should
consider this when developing their loan policies;
Page 1011-6
0 Availability of funds. Credit unions should consider sources for

their funding of loans;
Competition. A credit union should price its loans competitively by

remaining aware of the rates national and local lenders offer their
members and customers;
0 Cash flow. Credit unions must tie their loan policies into their
overall funds management program and must provide for cash
flow, as well as, profitable return. As such, they should carefully
weigh single payment loans and balloon notes in terms of the
likelihood of repayment and the negative effect on liquidity. Credit
unions should also exercise care in establishing a real estate loan
program in which repayment terms of 15 years or more can affect
cash flow and income, particularly if real estate loans make up a
large portion of the loan portfolio; and
0 Pricing. Credit unions should establish and continuously monitor

their loan rates to ensure an adequate spread for the cost of funds,
operating expenses, reserve requirements, and profitability goals.
Other pricing considerations include market competition, loan
demand, and asset liability management strategies.
The following credit evaluation considerations apply:
0 Adequate borrower information. Credit unions should obtain

complete credit information on borrowers. A complete and
accurate application enables the credit committee or loan officer to
assess the applicant’swillingness and ability to repay. This
information also helps the collection staff, if needed.
Completed loan application. The loan application should

document the applicants’ income source and stability, as well as
their current obligations. Staff can better determine the applicant’s
“capacity to repay” by verifying the monthly obligations through
credit reports, and reported income using one of the following:
- A copy of a recent pay stub. This will verify employment, as

well as income. The loan processor should review hourly
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EXAMINER'S GUIDE
wages, salary, or year-to-date income, as stated on the pay stub.

'They should also alert themselves to any wage garnishments;
- A documented phone contact or written verification to the

employer or credit union sponsor (the sponsor may have
income information or pay scale based on position and length
of service);
- A complete copy of the most recent signed tax return or

independently prepared and audited financial statement, for
self-employed borrowers. By obtaining two years' tax returns,
the credit union can develop a trend analysis to better analyze
self-employed borrowers' cash flows and income levels over
time; and
- A copy of the lease or rental agreement, tax return, or pay stub,

when the applicant lists "other income" (e.g., rental,
investment, or second job.)
Many credit unions with stable fields of membership and one

primary sponsor may know their borrowers' relative income levels
and past payment histories. Examiners should consider such factors
in conjunction with loan loss and delinquency levels when
evaluating the issue of income verification. Many competing
lenders do not verify income. Competition and member service
could override documentation considerations in credit unions with
good lending performance.
0 Terms of repayment. Credit unions should base loan repayment

terms on the purpose of the loan, the collateral, and policy
constraints. The terms also must coincide with the provisions of
the FCU Act and NCUA Rules and Regulations.
0 Collateral. The principles regarding collateral and the actions

required by the officials when accepting collateral for various types
of loans include:
- Sufficient equity in the collateral to diminish the applicants'

willingness to lose their investment;
Page 10/1-8
- Repayment schedules that reduce the loan balance as the

collateral depreciates;
- Collateral that can readily convert to cash; and
- Collateral that has a known value. For some types of collateral,
such as vehicles, the credit union can determine the value from
publications designed for that purpose. Other types of
collateral, such as boats and real property, should have a
written assessment or appraisal to document value.
0 Extension agreements and refinanced loans. The principles of

credit also apply to extension agreements and refinanced loans.
Credit unions should not use them as devices to cover up
delinquency problems. Generally, once a member with a previously
unsatisfactory repayment history has demonstrated the ability to
make three to six consecutive monthly scheduled payments without
added collection work, the credit union may consider extending or
refinancing that member's delinquent loan. The credit union should
have a written extension policy and the ability to identify or track
the performance of delinquent loans it extends or refinances.
Chattel lien instruments. Management decides whether a credit

union files chattel lien instruments or purchases chattel lien non-
filing insurance. It is management's responsibility to protect the
credit union and comply with the provisions of state and local laws.
Lending Examiners may evaluate lending practices by reviewing policies, board

Practices minutes, credit committee/loan officer minutes, and the loan files.
When assessing practices, the examiner determines the following:
0 The board establishes reasonable written policies to manage

delinquency and loan losses;
0 The credit committee or loan officers act within their written
authority;
0 The board establishes realistic loan limits and pricing, to the extent
of available funds;
0 The board establishes reasonable collateral requirements that
provide adequate protection to the credit union; and
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EXAMINER'S GUIDE
0 The board establishes written policies implementing an internal

loan review and grading system (if applicable) to identify credit
risk in the loan portfolio.
Credit Report Most credit unions use credit reports when evaluating a borrower's
Analysis creditworthiness. Occasionally, small credit unions use oral credit
reports but these can result in misinterpretation. Credit unions must
keep documentation of the oral credit report in the borrower's loan file.
Credit reports help determine the applicant's "character" and verify

outstanding debts. Credit unions should place a strong reliance on the
credit report and the member's payment history. A poor repayment
history and adverse credit report provide strong indications of whether
the member will repay the credit union. In general, credit unions
should pull a new credit report if the most recent credit report is more
than twelve months old.
When reviewing credit reports, loan officers should determine that:
0 Borrowers have listed all their debts on the application.

Reconciling the credit report to the application can identify debts
not listed. Credit reports do not include debts to institutions that do
not report to the credit bureau (e.g., some small credit unions, sub-
prime lenders.) To determine the memberk "capacity to repay,"
staff should consider all the obligations including the new loan.
0 The credit ratings indicate a good, slow, or poor past payment

history. Some credit reporting agencies (Experian, Equifax, and
Trans Union) quantify payment histories into risk scores. The risk
scores indicate the probability of loan default and the member's
probability of filing for bankruptcy in the future. If credit unions
use a risk score rating system as part of their loan underwriting
process, they should understand the system well enough to explain
it.
0 Excessive numbers of inquiries over the past year (which may

indicate financial problems or excessive pending new credit) are
explained.
Page 10/1-10
The credit union should not automatically deny a loan because of a

member’s adverse credit history. A member having experienced a
layoff or serious medical condition could have a poor prior record. If
the credit union approves a loan to a member with an adverse credit
history, the credit union should adequately document the reasons for
the approval and show the member has resolved the reasons for the
adverse ratings.
Members can have problems “below the surface” even if all ratings
show positive. Many revolving lines of credit at or near the maximum
limits can signal potential over extension or “pyramiding.” Reviews of
bankruptcies indicate many members were current prior to filing
bankruptcy. Comparing past credit reports to present credit reports can
identify pyramiding debt. Characteristics of pyramiding debt include:
0 Using new credit to pay old debt, especially the use of unsecured
credit to consolidate credit card debt;
0 Escalating debt outpaces income; and
0 Increasing numbers of recent credit report inquiries, which can
indicate either lender denials or unreported new debt, as some
lenders report inquiries but do not report new loans.
Capacity to A major consideration in granting loans is the analysis of the

Repay member’s capacity to repay. Calculation of a debt ratio (monthly
obligations to income) remains a standard method of analyzing the
ability to repay.
Credit unions must also consider the member’s level of income when
making loan decisions. For example, members with higher levels of
income can often handle higher debt ratios. This type of review,
referred to as a Net Disposable Income Analysis, can help determine
the members’ capacity to repay. All loans granted to members with
limited capacity to repay should have an overriding reason noted in the
file.
Credit Scoring Credit scoring systems attempt to statistically predict the likelihood of
a member defaulting on a loan. Regulation B requires statistically
derived and empirically sound credit scoring. Fair, Isaac and Company,
Page 10A-11
EXAMINER’S GUIDE
Incorporated, a financial service organization, pioneered credit scoring

and provides many of today’s credit scoring tools. Other sources of
credit scoring include a credit union’s custom model or a score
obtained from one of several credit reporting agencies. Credit reporting
agencies also offer preapproval screenings based on “canned”
prescreens or individually developed queries. In general, credit unions
outsource the development of a credit-scoring model to minimize
costs, while taking advantage of the marketplace expertise.
Advantages of credit scoring include (1) quick loan turnaround, (2)

consistency in lending, and (3) basis for risk pricing. Many credit
unions use credit-scoring models to market loan products, such as pre-
approved auto and credit card loans. Credit scoring allows these credit
unions to send out pre-approved mass mailings to targeted groups.
Credit unions use credit scoring as the basis either for loan decisions or
as a loan officer’s tool in a judgmental loan decision. Credit unions
manage the volume of loans and level of risk assumed by setting credit
score ranges loans must meet.
When a credit union uses credit scoring, loan policies and procedures
must outline how the credit union will do the following:
0 Apply them consistently;

0 Validate them. At a minimum, the credit union should test and
validate the credit scoring model at least every two years; and
0 Track their results. For example, if unexpected delinquency results
from credit scoring, the credit union should consider modifying the
underlying parameters of the scoring model.
Some credit unions contract with third parties to perform credit

scoring. The contract must set forth the responsibilities of the parties,
including who assumes responsibility for ensuring that the credit
scoring meets applicable regulations. The credit union should ensure
that:
0 Staff receive adequate training and understand the credit-scoring

model. Loan officers should understand the system, its
components, and its limitations;
Page 10/1-12
Management obtained a written legal opinion that states the credit

union has met all applicable regulations and has adequately
protected itself;
Management tracks credit scored loans and recalibrates the credit
scoring model when necessary; and
Indirect lenders can only authorize approval for loans to members.
The third party contract must exclude loans to non-members.
Paperless Credit unions constantly search for ways to deliver services more
Lending efficiently to members. Credit unions have systems to take loan
applications via audio response systems, fax, and the Internet. Often,
credit unions using these paperless systems order credit reports and
compare the application information entered by the member with that
on the credit report. Simple logic programs analyze the member’s debt
ratio, credit history, disposable income, etc., and either approve the
loan request, or refer it to the staff for further action. Some systems
may even complete and disburse the loan electronically.
Examiner When reviewing a paperless loan system, the examiner should

Guidance determine the credit union addressed the following areas:
Data integrity. Credit unions must secure application information

collected by the system, protect it from access by unauthorized
parties, and provide it in a form that users can readily access;
Regulatory compliance. The application should comply with

applicable consumer regulations (e.g., give the member the
opportunity to apply for the loan individually or jointly, properly
address community property issues, and meet Equal Credit
Opportunity Act (ECOA) criteria.) Further, the credit union should
have an attorney’s opinion stating that the paperless application
constitutes a legal loan application;
Collectibility. If the system completes and disburses the loan, the

credit union should retain an attorney’s opinion stating that the
loan represents an enforceable debt or security interest and
addresses the ECOA issues as to enforceability against co-
applicants, co-makers, or guarantors;
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EXAMINER’S GUIDE
0 Internal Controls. The credit union must maintain a record of all

loans approved or referred by the system. Loan officers (or the
credit committee) must properly act upon system-approved and
referred loans. The internal control manager, assigned staff person,
or outside auditor, who has no involvement in lending, should
review this record and management’s documented inspection to
affirm the credit union makes no unauthorized loans; and,
0 Documentation. Examiners should review the adequacy of the

documentation and disclosures the paperless loan system generates
for the credit union and the member. Some systems may only
generate an information summary showing the data entered by the
member. Credit unions may compensate by taking a master
application before allowing a member to use the “paperless loan”
system, in order to meet application disclosure requirements.
Risk-Based NCUA Letter to Credit Unions 99-CU-5 and 174 address risk-based
Lending lending. Risk-based lending involves setting a tiered-pricing structure
that assigns loan rates based on an individual’s credit risk. Profitable
risk-based lending requires the surcharge rates charged by the credit
union cover the loan loss rates and overhead costs related to
underwriting, servicing, and collecting these loans. Credit unions that
cannot justify and support pricing differences based on risk will face
heightened compliance and reputation risks if pricing decisions appear
to result in disparate treatment under consumer protection regulations
(e.g., ECOA.)
Credit unions that engage in risk-based lending should have in place:
Strategic and business plans that acknowledge the additional

inherent risks and provide for the necessary resources, including
specialized management and staff expertise, to manage the risks;
Policies and procedures approved by the board that define the

parameters of the risks assumed and internal controls necessary to
ensure acceptable portfolio quality;
Page 10/1-14
0 Information systems capable of providing monitoring information

sufficient to analyze the results of underwriting, operations, and
pricing decisions;
Quality control systems that provide feedback on the adequacy of

and adherence to underwriting, operating, pricing, and accounting
guidelines;
Compliance management programs that identify, monitor, and

control consumer protection problems associated with risk-based
lending; and,
0 The level of net worth needed to support the additional risks

incurred. Examiners may review the credit union’s documentation
of its method used to determine the amount of capital necessary,
and may evaluate the overall capital adequacy on a case-by-case
basis.
Large Loans Examiners can often evaluate concentration risk by measuring

and Concen- concentrations as a percentage of total loans or total equity. (Smaller
trations credit unions may find this more appropriate than larger credit unions.)
Examiners may also find the pre-built queries in AIRES benehcial for
identifying large loans and concentrations of credit. In both large and
small credit unions, examiners may benefit from developing
continuing workpapers for tracking large loans and concentrations of
credit from one examination to the next.
AIRES The AIRES Questionnaire workbook contains various loan

questionnaires. These checklists further document the examiner’s
review of various loan types. Use of the questionnaires can also assist
the examiner in reviewing unfamiliar loan types. Depending on the
credit union’s services offered, optional questionnaires may address
controls in the following lending areas:
0 Real Estate
0 Line of Credit
0 Leasing
0 Indirect Lending
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EXAMINER'S GUIDE
0 Home Equity
Credit Cards
0 Construction
0 Collections
0 Adjustable Rate Mortgages
0 Agricultural
0 Member Business Loans
Workpapers AIRES Workpapers, Documents and Questionnaires

and - Review Considerations
References Loan Analysis
Loan Exceptions Document
Loan Review
Key Ratios
Critical Loan Input
Real Estate Lending Controls
Adjustable Rate Mortgage Lending Controls
Construction Lending Controls
Business Lending Controls
Agricultural Lending Controls
Line of Credit Lending Controls
Credit Card Lending Controls
Automated Teller Machine Controls
Regulation M - Consumer Leasing
Regulation Z - Truth in Lending
Regulation Z - Variable Rate Loans
Allowance for Loan and Lease Losses Module
Manual Loan Classification
0 References
107(5) - Authority to Make Loans
107(11) - Statutory Liens
107(13) - Purchase of Eligible Obligations
114 - Credit Committee
Article IX - Credit Committee
Article XI1 - Loans to Members and Lines of Credit
Page 1011-16

70 1.21 - Loans toMembers and Lines of Credit to
Members
701.22 - Loan Participation
70 1.23 - Purchase, Sale, and Pledge of Eligible
Obligations
702.402 - Full and Fair Disclosure Required
722 - Appraisals
723 - Member Business Loans
- IRPS 83-3 - Financing Leases
- Chartering and Field of Membership Manual
- NCUA Letter No. 119
- NCUA Letter No.99-CU-5
Page 1011-17
&-/d u
Chapter 10 - Part 2
LOANS - CREDIT RISK, DELINQUENCY, & CHARGE

OFFS
Examination Determine the credit risk within the loan portfolio
Objectives 0 Determine if the credit union reports delinquency accurately and in
a timely manner
Determine if the credit union has appropriate and adequate
collection policies and procedures
0 Determine if the credit union makes appropriate and adequate
collection efforts
Determine if the credit union has implemented reasonable
extension and refinancing policies and procedures
Determine reasonableness of the charge-off policy
Associated 0 Credit risk occurs when the borrower cannot repay according to the
Risks terms of the loan;
0 Liquidity risk occurs when the failure to collect problem loans
affects available funding sources;
0 Transaction risk occurs when delinquent loans are not properly
aged; and
0 Reputation risk occurs when delinquency or collection efforts (or
lack thereof) affect the credit union’s image.
Overview Management’s responsibility includes identifying and monitoring

credit risk, delinquency, and charged-off loans on an ongoing basis.
Eva1uating There are two purposes for reviewing the loan portfolio:
Credit Risk
0 Assessing the level and direction of credit risk, and
Determining the potential risk to the NCUSIF.
Adequate funding of the ALLL andor low delinquency and loan loss
ratios do not necessarily mean the credit union properly mitigates its
credit risk. Credit unions should also have a quality control process by
which they review the loan portfolio or components of the loan
Page 1012-1
EXAMINER’S GUIDE
portfolio to determine if risk factors exist that, if left unattended, could

adversely affect the overall quality of the loan portfolio.
Examiners may review the credit union’s quality control process. The
goal is to ensure management can assess the risk in its portfolio and
monitor potential future exposure. The credit union may prepare lists
to monitor and assess delinquent loans, other problem credits, and
special mention loans. The preparation and maintenance of these
reports vary among credit unions and largely depend on the credit
union’s resources and sophistication. Tracking the information on
these lists enables management to assess the performance of the loan
portfolio and act to mitigate risk therein through changes in policies
and/or procedures. If the credit union has an adequate process for
evaluating credit risk, examiners need not perform a detailed review of
the loan portfolio.
Other problem credits usually include past due loans, leases, and
accounts receivable; however, they may also include non-delinquent
loans of members experiencing a recent layoff, loans especially
affected by a downturn in economic conditions, and loans that
circumstances indicate may become delinquent in the near future.
Special mention loans usually include loans that require special

monitoring by the credit union. These may include loans in new loan
programs, loans the credit union officials chose to grant that fall
outside the credit union’s loan policy, loans for which the credit union
has no prior experience, loans previously classified as problem credits,
and any other loan that requires additional attention.
If the credit union does not have an adequate quality control review
process, the examiner should review a sample of loans to assess the
level and direction of credit risk. This may involve creating a list of
loans that exhibit specific risk characteristics, to review from one
examination to the next. The Query Report Loan Watch List in AIRES
provides a tool that may assist examiners in tracking loans containing
significant existing or potential risk. In addition, the examiner may
review and track loans meeting certain criteria such as the following:
Page 1012-2
LOANS - CREDIT RISK, DELINQUENCY, PROBLEM CREDITS, & CHARGE OFFS
Loans having weaknesses that jeopardize full collection of the

debt, including the distinct possibility the credit union will sustain
some loss if it does not correct the deficiencies;
Loans where, even if collected, the credit union would incur

collection costs, which could be substantial;
Loans, both open-end and closed-end, past due 90 days from the
contractual due date;
Loans where it appears the credit union will not collect a

substantial portion, even though the borrower makes partial or
irregular payments;
Loans with inadequate documentation;
Loans that are current but represent potential losses to the credit
union due to questionable security;
Loans, that are current according to their terms, but represent

potential losses because of the payment terms or past practices.
This category might include single payment loans and "balloon"
loans that the credit union has repeatedly refinanced or extended;
Workout loans in which the credit union permanently amended the

original terms of the note to lower payments or reduce interest
rates. Workout loans generally allow the borrower to continue a
reasonable payment stream thus avoiding default; and
Any other loan as warranted.
Based on this review, the examiner may make recommendations to

management that would enhance the quality of their loan portfolio.
Examiners should direct their review toward determining the level and
direction of credit risk and the potential risk to the NCUSIF.
Delinquency Examiners should verify the credit union accurately reports

Control delinquency each month for all loan types. Credit unions must report
the total delinquent amount when reporting delinquency statistics,
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EXAMINER’S GUIDE
including loans handled by a third party (e.g., bankruptcy loans,

participation loans, student loans, credit card loans, and first mortgage
real estate loans.) An accurate list of delinquent loans enables the
examiner to evaluate collection policies and practices, and identify
delinquent loans for possible charge off.
Examiners may test a sufficient number of loans to determine the

reasonableness of the delinquent loan schedule. Examiners can
perform manual calculations and testing using a calculator, or they can
test electronically using AIRES or other computer programs (e.g.,
Excel.) If the loan sample tested reveals loans improperly categorized
or omitted from the delinquent loan schedule, the examiner should
design a workpaper to reflect the correct categories for these loans.
If no current, complete, or accurate delinquent loan schedule exists, the

examiner should establish appropriate plans with officials to develop
one. Examiners may retain a schedule of the delinquent loans in the
field file for reference.
NCUA does not require a credit union to use a particular loan

delinquency calculation method. Examiners may use one of the
traditional methods (in AIRES) as a simple measure for comparison
with a credit union’s calculated delinquency estimate. However,
examiners must understand the intent of these methods is to provide a
“reasonableness test.” Generally, credit unions must calculate loan
delinquency consistent with loan contract terms, which can vary
widely.
The delinquent loan schedule can serve as the basis for a loan review
sample. For example, a review of recently granted delinquent loans
might provide insight as to reasons for increasing delinquencies. The
Loan Exceptions workpaper can aid officials in revising policies and
practices to reverse an increasing delinquent loan trend.
During the delinquent loan review, the examiner may:
Determine whether staff follows the collection policies and

procedures;
Identify weaknesses within the collection policy or process;
Page 1012-4
Identify underwriting trends and weaknesses, and determine what

changes in procedures could have prevented the delinquency;
Determine if the credit union develops and properly monitors a
watch list of loans that require special attention; and
Review repossession, bankruptcy and foreclosure logs to evaluate
credit union control.
Based on a review of the Scope Workbook, the credit union’s 5300

risk parameters, and loan queries, examiners should determine the
level of risk posed by delinquency. An initial review of loans may
suggest understated delinquency and deserve a closer look.
Collection Examiners should review the loan loss ratio and the delinquent loan
Procedures ratio when evaluating collection procedures. These ratios show the
credit union’s past loss experience and its current potential loss
position. The adequacy of the collection program and the credit
union’s level of compliance with it provide an indication of the future
direction of delinquency. The composition of delinquency can also
indicate whether problems are recent or older.
Each credit union should develop a collection program appropriate for

its size, complexity, field of membership, and area. The program
should have definite, measurable goals (e.g., follow up on missed
promise to pay within 24 hours.) Collection programs usually share the
following common characteristics:
0 Prompt action. Early collection effort enhances the success rate of

collecting delinquent loans (e.g., within a few days of the first
missed payment, long before the loan appears on the monthly
delinquent loan list);
0 Repeated contacts. A collection effort should consist of a series of

payment requests, beginning with a gentle reminder and ending
with a firm demand for repayment. Collection staff should record
all collection contacts, and the results of those contacts, on a
collection card or computer system collection-working file;
0 Varied action. A collection program that combines letters and

personal telephone calls can prove quite effective. Collection staff
Page 10/2-5
EXAMINER'S GUIDE
should determine the "intent" of the delinquent member as early as

possible. If delinquent members cannot make h l l loan payments,
they should reach agreement with the credit union to make regular,
partial payments. As a minimum, the borrower should initiate and
maintain regular contacts with the credit union. If the borrower
does not establish "good faith" or "good intent," the credit union
should take stronger collection action;
0 Prompt follow up on failed promises. If borrowers do not follow

through with their promise to pay, the credit union should follow
up within a maximum of 48 hours;
0 Follow through. If the credit union does not follow through with its
threatened action, delinquent borrowers may believe they can
ignore the credit union; and
0 Proper paperwork. Although not considered part of a collection

program, staff must properly complete paperwork to reduce the
likelihood of legal action against the credit union.
Examiners should discuss deficiencies in the collection program,

policies, or practices with the appropriate officials. When encountering
weak collection procedures, examiners may document their review by
completing the Collection Program questionnaire in AIRES.
Examiners may also review previously charged-off loans. Often, credit

unions assign these loans to outside collectors. These outside
collectors should issue periodic status reports to the credit union. If
these reports indicate a lack of follow up, officials must take
appropriate action.
An "inverted" delinquency (more delinquent loans in the 6 to 12 and

12 months and over range than in the 2 to 6 months range) may
indicate a problem in the collection program. The examiner should
review the reasons for the inversions and, if necessary, reach
agreements with the board to improve the collection practices.
Inversion can also indicate the credit union does not charge off loans in
a timely manner.
Page 1012-6
In a "normal" delinquency condition, more loans exist in the 2 to 6

months range than in the 6 to 12 months and 12 months and over
ranges. Examiners may analyze the loans 1 to 2 months past due to
determine if a weakness in the collection program is beginning to
surface.
Erratic trends in delinquency, such as increasing delinquency followed

by a sudden decrease that does not relate to loan charge-offs, can
indicate potential abuse (e.g., due date bumping or fictitious loans.)
Examiners may expand the review if they note unusual trends.
Extension and Examiners may review extension and refinancing policies and
Refinancing procedures for reasonableness. At times, credit unions can effectively
use extension agreements or refinancing of delinquent loans as
collection tools; however, excessive extension agreements or
refinancing can mask delinquency. Credit unions should use extension
agreements or refinancing of delinquent loans only to help borrowers
overcome temporary difficulties, and after the borrower demonstrates
renewed willingness and ability to repay the loan.
Generally, credit unions grant extension agreements to delinquent

borrowers who have demonstrated their commitment to repay their
obligations by making substantial payments for at least three months
prior to approval. (Examiners should note that delayed disability
insurance payments for illness or circumstances such as recalls after a
layoff may justi@ extension agreements without the member
demonstrating three months of good faith payments.) The collection
department can prepare extension agreements; however, a loan officer
or credit committee must approve the transaction to assure segregation
of duties and avoid a conflict of interest.
Credit unions should refinance delinquent loans only after the

borrower has demonstrated a consistent effort and ability to repay.
Refinancing of delinquent borrowers that do not make consistent
payments could warn examiners of hidden delinquency.
As a general rule, credit unions should not extend or refinance a loan

more than once within a twelve-month period, or two times within a
five-year period. If the credit union has a history of frequently
Page 1012-7
EXAMINER'S GUIDE
extending or refinancing loans, the examiner should carefully review

the underlying reasons.
Credit Card The examiner may need to review the credit union's in-house
Collection procedures for delinquent credit card loans to ensure proper aging and
Program limited losses. Some processors only report delinquency up to 2 10
days, in which case the credit union must calculate and report the past
due months over 210 days.
Examiners should consider the following items when analyzing the

credit union's credit card collection program:
Procedures for listing delinquent, over limit, lost, or stolen cards in

a warning bulletin;
Procedures for blocking cards;
Procedures for reviewing over limit cards; and
Adequacy of bond coverage and deductible for fraud losses.
Bankruptcy Examiners should familiarize themselves with the basic terms and
concepts of federal bankruptcy law (Title 11, U.S. Code) in order to
make informed judgments concerning the likelihood of collection from
bankrupt members or member businesses (called "debtors" under the
bankruptcy law.) The following paragraphs present only an overview
of bankruptcy.
Complex situations may arise where examiners need more in-depth

consideration of the bankruptcy provisions that warrant consultation
with the credit union's counsel, regional office, or Office of General
Counsel. For the most part, however, knowledge of the following
information, when coupled with review of credit file data and
discussion with credit union management, should enable examiners to
reach sound conclusions regarding the eventual repayment of the credit
union's loans.
Forms of Liquidation and reorganization comprise the two basic types of

Bankruptcy bankruptcy proceedings. Liquidation, pursued under Chapter 7 of the
Relief law, involves the bankruptcy trustee collecting all of the debtor's non-
Page 1012-8
exempt property, converting it into cash and distributing the proceeds

among the debtor’s creditors according to a priority prescribed by
statute. In return, the debtor obtains a discharge of all debts
outstanding at the filing of the petition, thus releasing the debtor from
all liability for those pre-bankruptcy debts.
Chapter 1 1 or Chapter 13 of the law addresses reorganization and, in

essence, provides satisfaction of the creditor’s claims from the debtor’s
future earnings, rather than through liquidation of the debtor’s assets.
That is, debtors may retain their assets, but the court restructures their
obligations and implements a plan to pay the creditors.
All debtors (whether individuals, corporations, or partnerships), may

use Chapter 11 bankruptcy, regardless of the amount of their debts. On
the other hand, only individuals with regular incomes and unsecured
debts under $269,500 and secured debts less than $807,750 may use
Chapter 13.
The Chapter 13 reorganization plan represents essentially a contract

between the debtor and the creditors. Before confirming the plan, the
bankruptcy court must find that it was proposed in good faith and that
creditors will receive an amount at least equal to what they would have
received in Chapter 7 liquidation.
In Chapter 11 reorganization, all creditors may vote on whether or not

to accept the repayment plan. In Chapter 13 proceedings, creditors may
object to the proposed repayment plan only on the following grounds:
(1) they will not receive an amount at least equal to what they would
have received in a straight liquidation (the “best interest of creditors”
test); (2) the debtor is not required to pay all disposable income (i.e.,
income after payment of reasonable, current expenses) into the plan for
at least three years (the “best efforts” test); or (3) the plan is not
proposed in good faith (the “good faith” test.) The debtor may choose
to convert a Chapter 13 bankruptcy to a Chapter 7 bankruptcy.
Most cases in bankruptcy courts involve Chapter 7 proceedings. From

the creditor’s point of view, Chapter 1 1 or 13 filings generally result in
greater debt recovery than do liquidation situations under Chapter 7.
The courts tailor reorganization plans to the facts and circumstances
applicable to each debtor’s situation, which mean they vary
Page 1012-9
EXAMINER'S GUIDE
considerably, and the amount that the creditor recovers may similarly
fluctuate from nominal to virtually complete recovery.
Automatic s h y Filing of the bankruptcy petition requires (with limited exceptions)

creditors to cease or "stay" further action to collect their claims or
enforce their liens or judgments (12 U.S.C. $362.) Once filed, the
petition prohibits actions to accelerate, set-off, enforce a statutory lien
(NCUA Rules and Regulations §701.39), or otherwise collect the debt.
The petition also prohibits post-bankruptcy contacts with the debtor
(i.e., "dunning" letters.) The stay remains in effect until the bankruptcy
court releases the debtor's property from the estate, dismisses the
bankruptcy case, approves a creditor's request for termination of the
stay, or the debtor obtains or is denied a discharge. Two of the more
important grounds applicable to secured creditors for seeking relief
from the automatic "stay" follow:
0 The debtor has no equity in the encumbered property and the

property is not necessary to an effective reorganization plan; or
0 The court is not adequately protecting the creditor's interest in the

secured property.
In the latter case, the law provides three methods by which to

adequately protect the creditor's interests: (1) the creditor may receive
periodic payments equal to the decrease in value of the creditor's
interest in the collateral; or (2) the creditor may obtain an additional or
substitute lien on other property; or (3) the court arranges some other
protection (e.g., a guarantee by a third party) to adequately safeguard
the creditor's interests. If these alternatives result in adequate
protection for the secured creditor, relief from the automatic stay will
not be warranted. If the creditor obtains relief from the stay, creditors
may resume pressing their claims upon the debtor's property free from
interference by the debtor or the bankruptcy court.
Discharge - The discharge protects the debtor from further liability on the debts
Objections and discharged. In some instances, however, bankruptcy does not
Exceptions discharge debtors at all (i.e., the creditor successfully obtains an
"objection to discharge"), or discharges them only as regards a specific
Page 1012-10
creditor and a specific debt (an action known as "exception to

discharge.") In general, most unsecured debt is dischargeable, while
most secured debt survives bankruptcy as a charge on the property to
which it attaches. The debtor obviously remains liable for all
obligations not discharged, and creditors may use customary collection
procedures to collect these obligations.
"Obiections to Discharge." The grounds justifling an "objection to

discharge" include any of the following actions of the bankrupt debtor
(this list is not all-inclusive) occurring within twelve months preceding
filing of the bankruptcy petition: (1) transfer, removal, destruction,
mutilation, or concealment of property of the debtor or the estate, with
intent to hinder, delay, or defraud; (2) concealment, destruction,
mutilation, falsification, or unjustifiable failure to preserve records of
debtor's financial condition and business transactions; (3) making a
false oath or account, or presentation of a false claim to the bankruptcy
estate; (4) withholding of books or records from the trustee; (5) failure
to satisfactorily explain any loss or deficiency of assets; and (6) refusal
to obey a lawful court order or to testify when legally required to do so.
In addition, the debtor's receipt of a discharge in bankruptcy within six
years preceding filing of the present bankruptcy petition is a valid
ground for objection (1 1 U.S.C. $727(a)).
"Exceptions to Discharge." The grounds justifying an "exception to

discharge" include: (1) pre-bankruptcy income taxes; (2) money,
property, or services obtained through fraud, false pretenses, or false
representation; (3) debts not scheduled on the bankruptcy petition and
for which the creditor had no notice; (4) alimony or child support
payments (only the debtor's spouse or children may assert this
exception, property settlements are dischargeable); and (5) submission
of false or incomplete financial statements.
If a credit union attempts to seek an exception on the basis of false

financial information, it must prove (1) the written financial statement
was materially false, (2) it reasonably relied on the statement, and (3)
the debtor intended to deceive the credit union. The credit union may
find these assertions difficult to prove. Corporations and partnerships
cannot avail themselves of discharges; therefore, bankruptcy often
causes corporations and partnerships to dissolve or become defunct.
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EXAMINER'S GUIDE
Reaffirmation Despite a bankruptcy discharge, debtors may sometimes promise their

creditors they will repay a discharged debt. A common example
involves an unsecured loan with the credit union that the borrower
wants to reaffirm after discharge. This process of reaffirmation is
voluntary, but judicially enforceable agreement (1 1 U.S.C. $524(c);
Fed. R. Bankr.4008.) The principal requirements for a reaffirmation
agreement are:
0 The agreement between the debtor and the creditor must be made
(i.e., executed and dated) before the discharge is granted;
0 The agreement must inform the debtor that there is no legal
requirement to reaffirm (i.e., that reaffirmation is voluntary);
0 The court must reiterate that reaffirmation is voluntary and explain
the obligations imposed by the agreement and the legal
consequences if the debtor defaults; and
The agreement must give notice of the debtor's right to rescind the
reaffirmation agreement at any time before the discharge is
granted, or within 60 days after the agreement is filed in court,
whichever is later.
Transfers Not Under most circumstances, a credit union that fails to promptly perfect
Promptly its security interest runs great risk of losing its security. This is a
Perfected or complex area of the law, but prudence clearly dictates that the credit
Recorded union properly obtain liens and promptly file them to eliminate the
possibility of losing the protection provided by collateral.
Statutory Federal credit unions can take advantage of a statutory lien authorized
Lien by the Federal Credit Union Act 9 107( 11) and interpreted by IRPS 82-
5. Under this authority a federal credit union may (1) impress a lien
when granting a loan, by noting the existence of the lien in its records
at the same time it grants the loan, by stating in the loan documents
that borrowers pledge their shares and dividends to satisfy the lien or
to secure the loan, or by adopting a bylaw or board policy to the same
effect; and (2) enforce the lien by applying the shares and dividends
directly to the amount due on the loan (including the unpaid loan
balance together with interest, fees, and other charges) without
obtaining a court judgment, even if the credit union has allowed the
Page 1012-12
member to make withdrawals and even if state law requires a court

judgment before enforcing a statutory lien.
Three exceptions apply:
1. Regulation Z generally prohibits a federal credit union from

offsetting a borrower's indebtedness arising from a consumer credit
transaction under a credit card plan against funds that the credit
union holds (12 C.F.R. §226.12(d));
2. As concerns individual retirement accounts (IRAs), the Internal

Revenue Code (26 U.S.C. §408(a)(4)) requires that the "interest of
an individual in the balance in his account is nonforfeitable."
NCUA takes the position that federal credit unions should not
impress a statutory lien against an IRA without first obtaining
advice of either a tax advisor or counsel; and
3. The automatic stay of a bankruptcy court can stay the use of the
statutory lien, which, if impressed within the preference transfer
reversion period, could be an illegal preference and thus voided.
Examiners should also note two caveats regarding the statutory lien:
1. The credit union may only impress the statutory lien against the
debtor-member's accounts (e.g., in a tenancy-in-common account,
deemed to be a 50-50 split in the absence of other evidence, a
federal credit union could not place the lien against more than the
debtor's 50 percent interest; it cannot impress the lien against a
parent's account for debts of an emancipated minor); and
2. The statutory lien only applies in the loan context; a federal credit
union must adopt a nonstandard bylaw amendment or bylaw
resolution in order to debit a member's account for losses resulting
from another account (e.g., unpaid fees or service charges or
returned checks.)
Loan LOSS Ratio The Financial Performance Report (FPR) computes an annual loss
(Net Charge-Offs ratio termed net charge-offs to average loans, and provides a peer-
To Average group comparison (the amount of loss is shown per $1,000 of loans
Loans)
Page 1012-13
EXAMINER'S GUIDE
outstanding.) It also provides a historical trend of the net charge-off

ratio. The Key Ratios workpaper displays the loan loss ratio for prior
periods and the current ratio. The examiner should use this information
for both comparisons between credit unions and to supplement the
trend analysis. However, this ratio can be misleading.
For example, a low loss ratio could result from a board's reluctance to
recognize losses, which would be evidenced by a high delinquent loan
ratio. The examiner should compare the loss ratios over the periods to
detect trends. A high but declining ratio might indicate that the credit
union is correcting past problems. On the other hand, a credit union
might have a low but rapidly increasing loss ratio, which might
indicate an emerging problem.
The examiner should determine whether the credit union has a

reasonable and timely method of charging off loans. Moreover, the
examiner must verify the accuracy of the information on the NCUA
5300 report.
Charge Off of Credit unions should establish a policy for the regular charge off of
Problem uncollectible loans to avoid an intentional or unintentional
Credits misstatement of their net worth position. The Query Report Charge
Offs in AIRES provides a tool that may assist examiners in identifying
charge off loans, when necessary.
The board may adopt a policy that delegates to the manager the
authority to charge off loans. The board should approve the extent of
the delegation (i.e., the dollar amount and loan type), reflect the
approval in board minutes, and note the parameters in the written
collection policy or, more appropriately, written loan charge-off policy.
The manager refers loans that do not meet the established criteria to
the board. The policy should specifically prohibit the manager from
charging off loans when such charge off may constitute a conflict of
interest, such as loans to family members.
Management reports loans charged off under the delegated authority to

the board of directors at the next regularly scheduled meeting. NCUA
recommends that the board ratify all delegated charge offs.
Page 1012-14
LOANS - CREDIT RISK. DELINQUENCY. PROBLEM CREDITS. & CHARGE OFFS
The board of directors must periodically review compliance with the

charge-off policy. This policy may require the manager to comply with
IRS rules to report certain discharges of indebtedness.
When the credit union deems the loan a loss, it must charge off the
loan to the ALLL account. Loans that exhibit the following
characteristics present a high degree of credit risk, and the credit union
should consider them for charge off:
0 A non-performing loan more than six months past due without a

payment of at least 75 percent of a regular monthly installment
within the last 90 days. Transfers from shares and proceeds from
the sale of collateral do not constitute "payments";
0 A delinquent loan in the hands of an attorney or collection agency,

unless there are extenuating circumstances to indicate the credit
union will collect the loan;
A "skip," where the credit union has had no contact for 90 days;
0 An estimated loan loss, where the credit union has the repossessed,
but not yet sold, collateral on hand;
0 An account in bankruptcy, where the credit union has received

notification of filing from the bankruptcy court (e.g., loans
discharged in Chapter 7 bankruptcy within 60 days of receipt of
notification of filing from the bankruptcy court);
A loan under the protection of Chapters 11, 12, or 13 bankruptcy,

where the credit union has received no payments for six
consecutive months;
0 A fraudulent loan, when the loss is determinable;
0 A loan of a deceased person, when the loss is determinable;
0 A loan, where the remaining balance is a deficiency balance after

the sale of repossessed collateral and where the credit union has
received no payment and has no apparent course of action; and
Page 1012-15
EXAMINER’S GUIDE
0 A loan deemed uncollectible, where additional collection efforts

are non-productive regardless of the number of months delinquent.
Note: In Chapter 11 and 13 bankruptcy proceedings, if the court lowers

the amount that the borrower must pay, the credit union should
immediately charge-off that portion of the debt, which the court has
discharged. Examiners should note that the court frequently revises the
amount and terms of the debtor’s obligations. If the court changes the
terms of the debtor’s obligation, the credit union must also change the
terms of the obligation on the records (e.g., if the court changes the
interest rate from 12 percent to 9 percent, the credit union must lower
the rate to 9 percent as determined by the court.)
If the credit union does not maintain the ALLL account balance at a
sufficient level to permit the necessary charge offs, the credit union
must re-evaluate its ALLL funding methodology. Determining the
adequacy of the ALLL is not a by-product of the loan portfolio review.
Please see the ALLL chapter for a detailed discussion.
Collateral in When a credit union possesses loan collateral that is in the process of
Process of being sold, the examiner may evaluate the collateral for recoverable
Liquidation value. The examiner may document the evaluation on an examiner-
designed workpaper or on the list of collection problem loans. Misuse
of collateral in the process of liquidation can occur in credit unions.
The supervisory committee, in carrying out its auditing function,
should review this account and the collateral.
Other Real Estate OREO (other real estate owned) consists of foreclosed property where
Owned (OREO) ownership has passed to the credit union. A credit union often
acquires OREO through loan foreclosure. Generally, the credit union
intends to sell the real estate to partially or totally satisfy the loan
obligation.
The following definitions refer to OREO:
Cost - fair value at the date of foreclosure plus cash payments for capital
additions and improvements to the asset and, if applicable, related capitalized
interest subsequent to the date of foreclosure.
Page 1012-16
0 Fair value - the amount that the creditor could reasonably expect to receive in a
current sale between a willing buyer and a willing seller, that is, other than in a
forced or liquidation sale. Market value (if an active market exists) determines
the fair value of assets. If no active market exists for the assets transferred but
exists for similar assets, the credit union may use the selling prices in that market
in estimating the fair value of the assets transferred. If the credit union has no
market price available, a forecast of expected cash flows, discounted at a rate
commensurate with the risk involved, may aid in estimating the fair value of
assets.
Accounting for Credit unions should account for and value foreclosed assets acquired
OREO by the credit union as OREO as follows:
0 Presume OREO is "held-for-sale". The credit union should obtain

appraisals or broker price opinions and onsite inspections as
warranted to support the value of the property in question. (Note:
generally, federal credit unions cannot hold OREO for the
production of income. Therefore, this discussion of the accounting
rules for OREO is limited to OREO-held-for-sale.)
Record OREO at foreclosure at fair value less estimated cost to

sell. After foreclosure, the credit union should account for OREO
held-for-sale at the lower of fair value minus estimated costs to
sell, or at cost. Credit unions should periodically evaluate the
property for impairment and write down its carrying value if
warranted. Often foreclosures need substantial refurbishments,
such as new paint and carpeting, to make them marketable. Credit
unions should factor estimated refurbishment costs into the
carrying value.
0 Report as a liability the principal amount of any debt to which the

OREO is subject, and not deduct it from the carrying amount of the
asset (e.g., tax lien, mechanic's lien.)
Workpapers 0 AIRES Workpapers, Documents and Questionnaires

and - Supplementary Facts
References - Review Considerations
- Loan Analysis
- Loan Exceptions Document
- LoanReview
Page 1012-17
EXAMINER'S GUIDE
- Key Ratios
- Critical Allowance for Loan and Lease Losses Input
- Critical Loan Input
- Collection Controls Questionnaire
- Allowance for Loan and Lease Losses Module
- Manual Loan Classification
0 References
107(5) - Authority to Make Loans
107(11) - Statutory Liens
107(13) - Purchase of Eligible Obligations
1 14 - Credit Committee
Article VIII - Credit Committee
Article XI - Loans to Members and Lines of Credit
701.2 1 - Loans to Members and Lines of Credit to
Members
701.22 - Loan Participation
701.23 - Purchase, Sale, and Pledge of Eligible Obligations
702.402 - Full and Fair Disclosure
722 - Appraisals
723 - Member Business Loans
- IRPS 83-3 - Financing Leases
- Chartering and Field of Membership Manual
- NCUA Letter No. 99-CU-5
Page 1012-18
EXAMINER’S GUIDE
end credit obligation, without receiving the contractual right to obtain

extensions of credit under the obligation. Credit unions request a co-
signer’s signature as a condition for granting a member credit or as a
condition for forbearance on collection of a member’s obligation in
default. A spouse who must sign a credit obligation to perfect a
security interest pursuant to state law may not serve as a co-signer
(refer to §706.l(h) of NCUA Rules and Regulations.) §706.3(a)(2)
requires that co-signers receive specific written disclosures before
obligating themselves on a debt. Guarantor and endorser are terms that
also identifl- a co-signer.
The FCU Act 3 107(5) requires that co-makers be credit union

members (see legal opinion dated February 20, 1992.) The co-maker
shares in the loan proceeds and bears joint liability for repayment.
Thus, a credit union cannot make a loan to a nonmember co-maker.
However, a credit union may permit a nonmember to sign a loan,
provided the nonmember does so in the capacity of a guarantor (co-
signer), rather than a loan recipient (co-maker.)
Policies and Anyone of legal age (according to state law) to enter into a contract can
Procedures assume the responsibility of a co-signer. The credit union’s policy or
practice cannot require the co-signer be a member of the credit union
or a family member of the primary borrower (e.g., spouse or parent.)
The same credit principles used to determine an applicant’s ability to

repay also apply to co-signers and co-makers. For example, credit
unions should obtain a co-signer’s credit report and perform a debt
ratio analysis that includes the new payment. Credit unions may not
change loan terms or the security pledged without the co-signer’s
consent.
Effective collection programs include notification to both co-signers

and co-makers upon initial default of the obligation. If the member
cannot or will not pay, the credit union should pursue repayment from
the co-signer or co-maker, just as if they had received the proceeds of
the original loan.
Bankruptcy cases require different procedures. If the primary debtor

files under Chapter 13, the credit union must cease all collection
Page 10A-2
LOAN TYPES - APPENDIX 10A
efforts against both co-signers and co-makers. If the primary debtor

filed Chapter 7, the credit union should continue collection efforts
against both co-signers and co-makers.
Credit unions should remain aware of groups of members who co-sign

each other’s loans. This practice, called “round-robin” co-signing can
quickly result in an unsafe and unsound situation. Some data
processing systems track co-signer obligations, but many cannot.
Credit unions should institute a tickler system to track the member’s
co-signer obligations.
Lines of A line of credit is a preapproved fixed amount a member may draw on

Credit and replenish by repayment of amounts previously drawn. The
agreement specifies the amount the borrower may access and the
conditions of the agreement. Cancellation may occur upon notice by
either party.
Some ways to access a line of credit include:
0 Check or cash disbursements. Many credit unions accept telephone

or mail requests. The check used with these transactions should
bear a restrictive endorsement similar to the following:
Endorsement of this check by member acknowledges receipt

of proceeds resulting from the transaction and agreements set
forth on the detachable portion of this check and constitutes
acceptance of the conditions of the agreements, which are
hereby incorporated by reference.
0 Automated Teller Machines (ATM.) The ATM verifies the card

and requests an advance amount. The machine processes the
request and provides the funds, a receipt, and a record of the
transaction.
0 Share draft overdraft loans. The line of credit agreement is separate

from the share draft agreement. The share draft agreement must
specify the authorized amount and include authorization for the
credit union to transfer the amount of loan advance to the share
draft account.
Page 10A-3
EXAMINER'S GUIDE
0 Loan drafts. The drafts are similar to a bank check. Encoding

allows the draft to travel through the check clearing system to the
credit union's bank for payment.
0 Credit cards. A credit union either issues credit cards itself or

enters into an agreement with a credit card processor to issue credit
cards, such as "VISA" or "MasterCard" to its members for
processing against the members' lines of credit.
Internal Failure to protect plastic card programs represents a significant safety

Controls for and soundness concern. A credit union should assess the adequacy of
Plastic Cards the loss prevention measures in its plastic card programs. Loss
prevention measures, such as the following, reduce or prevent fraud
losses:
0 Card Activation. Processors should send new plastic cards to

legitimate cardholders in an inactive mode. Before using the card,
legitimate cardholders activate the card by going through customer
verification procedures. Card activation programs can significantly
reduce the loss of plastic cards in the mail.
0 CVV/CVC (Card Verification Value/Card Validation Code.)

VISA'S Card Verification Value (CVV) and Mastercard's Card
Validation Code (CVC) combat counterfeit fraud by using numbers
encoded on the magnetic stripe of credit and debit cards. When the
merchant passes the card through the point of sale reader, the
transaction will be rejected and not receive authorization if the
special code on the card does not exist or does not match the code
maintained by the processor. However, for CVV/CVC to work, a
credit union must have its authorization mode set to decline the
authorization. Credit unions should confirm:
- Their processor implemented CVV/CVC coding;

- The CVV/CVC is fdly operational and being read on all cards;
and
- The settings on its authorization response codes will decline the
authorization for all credit and debit transactions.
Page 10A-4
0 Neural Network. Neural networks track spending patterns of both

cardholders and typical fraud type transactions. Effective systems
monitor transactions 24 hours a day, seven days a week.
Monitoring The credit union should periodically obtain information concerning the
LinesOf Credit borrowers' current income and their repayment records on other debts.
Industry norms require updated credit reports for lines of credit every
two years. This review of a borrower's financial condition could help
management determine whether to increase, decrease, or terminate a
borrower's credit line.
Open-End An open-end loan is similar to a line of credit plan. The primary

Loans difference is that a line of credit plan has preapproved advances,
whereas, each open-end loan advance must receive loan officer or
credit committee approval.
A member applying for an open-end loan completes a personal and

credit information sheet, similar to a loan application except it usually
does not ask for an amount or purpose. The applicant also completes
an "open-end" note combined with the consumer credit disclosure.
Request vouchers document loan advances, which include an amount,

purpose, and terms of repayment. If the applicant's signature does not
appear on the request voucher, the check must contain a restrictive
endorsement, acknowledging the advance under the open-end loan
plan. The credit union may request updated financial information or
credit reports every few years to ensure the member's creditworthiness
has not deteriorated.
Variable Rate Variable rate loans have interest rates tied to an index and margin.
Loans These loans pass some of the interest rate risk to the borrower.
Movement in the index causes a change in the interest rate, which in
turn causes a change in the monthly payment, the loan maturity, or a
combination of these. While indices fluctuate over time, the margin
(e.g., 100 basis points) remains fixed over the life of the loan. The
index plus the margin equals the rate charged on the loan.
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EXAMINER'S GUIDE
Following are some of the more common indices:
Treasury Indices:
- One-Year Constant Maturity U.S. Treasury (CMT) Securities
(most common of the Treasury-based ARM indices);
- Six-Month U.S. Treasury Bills; and,
- Three-Year CMT Securities.
0 London Interbank Offered Rate (LIBOR) indices:

- Six-Month LIBOR as published in The Wall Street Journal;
and,
- Six-Month LIBOR as posted by Fannie Mae.
0 Cost of Funds indices:
- 1l h District Cost of Funds index (COFi);
- Federal Home Loan Bank Board (FHLBB) Monthly COFi;
- National Monthly Median COF Ratio; and,
- National Contract Rate.
Prime Rate as published in The Wall Street Journal (most common

index for Home Equity Lines of Credit.)
Laws governing Home Equity Lines of Credit (HELOCs) prohibit use

of an internal cost of funds. Regulation Z also requires credit unions to
prepare disclosures for variable rate loans showing the following:
0 Circumstances under which the rate may increase;

0 Any limitation on the increase;
0 The effect of an increase, which refers to an increase in the number
or amounts of payments or an increase in the final payment; and,
0 An example of the payment terms that would result from an
increase.
Variable rate loan review procedures include these additional steps:
Determine the adequacy of policies, procedures, and internal

controls for ensuring accurate rate change adjustments;
0 Verify the credit union determined the borrower's ability to make
the higher payment if interest rates increase;
Page 10A-6
Review the variable rate log book or the computer program to

veriQ the credit union has made accurate changes;
Review the rate change notification sent to the member to verify
the notification conformed to the terms of the note;
Determine whether internal or external auditors or other staff
periodically test the loan servicing system for accuracy; and,
Determine the accuracy of the rate change adjustments.
Guaranteed Credit unions may offer guaranteed student loans that are part of the
Student Federal Family Education Loan Program (FFELP.) Credit unions must
Loans receive approval to participate in FFELP and have strict monitoring
procedures in place to maintain the program. Under FFELP,
administered by the Department of Education (DOE), private lenders
provide the loan principal and the federal government guarantees
through a state agency the loan’s principal and interest up to 98
percent. If the student or parent borrower defaults on the loan, the
government reimburses the lender.
Granting and processing student loans differs from most other types of
loans. Student loans are normally granted to nonworking students who
attend school at least half time. The borrower’s current ability to repay
does not serve as the basis for the granting of student loans. This type
of loan requires less credit risk analysis.
Most credit unions offering student loans accept and process the
application, disburse the funds, and portfolio the loan while the student
is in school. When the student graduates, the credit union may sell the
loan on the secondary market. Credit unions may receive interest from
the guarantor while the student is in school, then they may transfer the
time consuming and extensive due diligence process to another entity
when the student graduates.
Due Diligence The credit union must perform due diligence on outstanding student
on Student loans. On subsidized student loans, the credit union must complete and
Loans send a billing report to DOE quarterly to receive interest due. The
credit union also must update the status of the student borrowers at
least annually (normally through a mailing) to obtain current school
information and addresses.
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EXAMINER’S GUIDE
Maintaining federal insurance on student loans requires that credit

unions comply with all due diligence requirements, especially during
the repayment process. Credit unions must make specific minimum
telephone and written contacts to meet DOE’s due diligence
regulations. Violations occur when a credit union misses a contact or
does not comply with the regulations. Violations of the DOE’s
regulations can result in loss of the government guarantee. Numerous
violations may result in loss of the guarantee on the entire portfolio.
The DOE may also levy fines for noncompliance. In addition, each
state involved in the student loan process has its own required
regulations and procedures. Credit unions often sell the student loan
servicing to avoid the extensive due diligence requirements.
If the credit union appears to have significant risks associated with the
student loan portfolio, examiners should determine the credit union has
the following:
Documented, comprehensive policies and procedures that

adequately address the requirements of DOE, the secondary
market, the guarantor, and the servicer;
Adequate tracking methods for student loans;
Delinquent loan list that includes delinquent student loans (even
though they are guaranteed);
Timely interest claims;
Adequate training for management and employees that includes
familiarity with DOE regulations;
Well-documented and complete loan files;
Adherence to the 50-50 rule (i.e., the credit union cannot have
more than 50 percent of total loans in student loans); and,
Additions to the collection policy that address specific
requirements of DOE.
Real Estate NCUA Rules and Regulations $701.2 1 addresses real estate lending.
Loans Well-planned and well-executed mortgage lending can offer
advantages to the credit union including member loyalty, opportunity
for cross-selling, good return and dependable cash flow. Credit unions
should underwrite loans to ensure their eligibility for sale in the
secondary market, unless they fit a specific exception created in the
credit union’s real estate policies.
- .
Page I O A - ~ -
LOAN TYPES - APPENDIX 1OA
Review procedures for these loans could determine the existence of the
following potential higher risk loans:
0 Loans over $50,000 which meet the requirements of $723.1 are

considered member business loans; and,
0 Loans made to a "blind trust" (a trust whose beneficiaries'
identities are hidden) are high risk and can cause significant losses
when members use these trusts to avoid restrictions on
concentrations of loans.
Real estate loan review procedures could include these additional

steps:
0 Assess interest rate and liquidity risks associated with the terms
and rates offered;
0 Determine if policies and procedures address credit and collateral
risk;
0 Determine sufficiency of controls to ensure compliance with
internal policies and minimum documentation requirements;
Ensure the mortgage program is part of a well-planned and well-
executed strategic plan;
0 Evaluate reputation risk involving service to members and dealings
with outside vendors; and,
0 Ascertain compliance with the NCUA Rules and Regulations,
individual state statutes, and other applicable consumer compliance
laws and regulations.
The Secondary After originating mortgages in the primary market, buying and selling
Market of mortgages take place in the secondary market. The two biggest
purchasers of mortgages are the Federal National Mortgage
Association (FNMA or "Fannie Mae") and the Federal Home Loan
Mortgage Corporation (FHLMC or "Freddie Mac.") Using their
experience in the mortgage market, FNMA and FHLMC have
determined an appropriate level of credit risk and established standards
to control this risk.
NCUA Letter to Credit Unions Nos. 124 (June 1991) and 99-CU-12
(August 1999) provided credit unions with real estate lending
guidelines. Credit unions should originate their loans in conformity
Page 10A-9
EXAMINER'S GUIDE
with secondary market standards; however, not all of a credit union's

loans must necessarily meet this standard. Credit unions should also
account for real estate loans, especially first mortgages, based on
industry standards of 30-day montW360-day year, with a 15-day grace
period and explicitly defined penalties. Departure from industry
standards incurs additional risk.
Appraisals Lenders use appraisals to determine the value of the collateral. Part
722 of the NCUA Rules and Regulations specifies the following:
0 Identifies which real estate-related financial transactions require

the services of an appraiser;
0 Prescribes which categories of federally related transactions a state-
certified appraiser shall appraise and which a state-licensed
appraiser shall appraise; and,
0 Prescribes minimum standards for the performance of real estate
appraisals.
Appraisers normally use various valuation approaches. The valuation

section of the appraisal provides the appraiser's support for the market
value based on the cost approach, the sales comparison approach
(market data approach), and the income approach. The appraiser
usually places more weight on the sales comparison approach in the
case of owner-occupied homes. The appraiser must report a minimum
of three comparable sales as part of this approach.
FNMA and FHLMC have established guidelines for net and gross
percentage adjustments. Generally, the dollar amount of net
adjustments for each comparable sale should not exceed 15 percent of
the comparable's sales price. The dollar amount of the gross
adjustments, without regard to the positive and negative signs, for each
comparable should not exceed 25 percent of the comparable's sales
price. The appraiser should also use comparable sales settled or closed
within the last 12 months. When the adjustments fall outside the 15/25
guidelines, comparable sales are more than six months old, or
comparables are not in close proximity to the subject property, the
appraiser should provide a written explanation. Ultimately, credit
unions must accept sole accountability for the appraisal's accuracy.
Page 10A-10
Loans meeting the following criteria may not require a full appraisal:
0 The loan is under $250,000;

0 The loan is for less than 50 percent of the property's value;
0 The loan was planned to fit a specific exception created in the
credit union's real estate policies; therefore, the credit union does
not plan to sell the loan in the secondary market; and,
0 The loan does not meet the requirements for an appraisal in Part
722 of the NCUA Rules and Regulations.
In these restricted circumstances, $722.3(d) requires the credit union to

obtain a written estimate of market value, "performed by an individual
having no direct or indirect interest in the property, and qualified to
perform such estimates of value for the type and amount of credit
being considered.''
Evaluating When selecting an appraiser, credit unions must follow the specific
Appraisers requirements and restrictions outlined in Part 722 of the NCUA Rules
and Regulations. In addition, the credit union should consider the
following standards for selecting an appraiser:
0 A minimum of two years of appraisal practice;

0 A license or certification from the appropriate state; and,
0 Insurance for errors and omissions.
Holding Theoretically, lenders can sell any loan or portion of a loan. However,
Selling poorly documented or poorly underwritten loans may sell at reduced
Loans prices. Once a borrower has established a payment history (i.e., the
loan is "seasoned"), buyers may relax documentation and underwriting
requirements. Sometimes the credit union may find it advantageous to
hold loans and sell them later as "seasoned" loans.
Credit unions may sell loans with or without recourse. The credit union
must repurchase loans sold with recourse if the borrower defaults, even
if it meets standard representations and warranties.
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EXAMINER'S GUIDE
Servicing Servicing constitutes all actions necessary to ensure proper handling of

Mortgage mortgage loans from the time of disbursement until finalization, by
Loans payoff, or charge-off. Servicing mortgages carries a significant amount
of transaction risk. Credit unions must have all related practices in
writing and follow them carefilly. The required procedures include the
following:
Escrow accounts for the payment of taxes and insurance;

0 Calculation of changes in payment for adjustable rate loans; and,
0 Collection efforts regarding delinquent loans.
Servicing When a credit union sells a loan, it has three servicing options: (1)
Rights: Sell or perform servicing itself, (2) sell its servicing rights to a second party,
Keep or (3) contract for servicing activities from a second party while
maintaining control and ownership of those rights. Credit unions that
sell or contract their servicing duties must ensure they deal with a
reputable servicer.
Loan servicing can generate profit. Annual income may range up to

one-half of one percent of the outstanding balance of the payments
collected. At the same time, credit unions considering servicing loans
must understand the labor-intensive nature of this activity and the
importance of economies of scale. Credit unions that do not generate a
large volume of loans may find it expensive. Generally, a servicing
portfolio requires $50 million or more to breakeven.
Selling of If the credit union sells the servicing rights, it must ensure the servicer
Servicing can meet the standards for servicing required by the secondary market.
Rights The following list, while not all inclusive, addresses the most
important items:
0 The purchaserhervicer is reputable. The credit union should

investigate the financial soundness and business history of the
servicer.
0 The credit union has a contract with the purchaser/servicer that

addresses the following:
Page 10A-12
- Timeframes for remittance of payments. The member sends the

required monthly payment to the servicer. The contract should
determine when and under what conditions the servicer remits
the principal and interest portion to the credit union;
- Information system. The servicer must have adequate

information system processing capability to maintain accurate
accounting and mortgage payment records. The credit union
should maintain the right, by contract, to examine the records
pertaining to the mortgages the servicer handles;
- Delinquency control. The servicer must perform collection

activities mandated by the secondary market, including
counseling procedures used with the borrower when trying to
avoid or cure delinquency;
- Collection needs. The servicer should have established

collection policies and procedures. Policies should address:
i. Actions taken by the servicer if the property requires

repairs and the owner either cannot, or will not, pay for
them;
ii. Procedures to control and monitor bankruptcy

proceedings; and
iii. Guidelines addressing when to use an attorney and who

will pay attorney's fees and associated costs;
- Foreclosure responsibilities. Servicer must familiarize

themselves with the local and state requirements for all loans in
its possession. In addition, some secondary market investors
and insurers have specific foreclosure requirements;
- Filing of IRS forms. An important servicer responsibility

involves timely filing of all IRS forms;
- Submission of periodic financial information. Credit union

officials should periodically review the servicer's financial
condition to ensure it operates safely and soundly;
Page 10A-13
EXAMINER'S GUIDE
- Servicer's insurance and bond protection requirements.

Insurance policies must indemnifjr the servicer against losses
resulting from dishonesty or fraudulent acts committed by the
servicer's personnel and employees of outside firms that
provide information systems and technology services for the
servicer. Servicers must also have an errors and omissions
policy to protect them against negligence, errors, and omissions
in meeting the legal paperwork requirements;
- Accounting Records. Accounting records must identify the

application of payments received on all loans. The servicer
should provide the loan owner a monthly breakdown of the
payment applications, based on the distribution of funds
received;
- Onsite inspection requirements. The need and frequency of

onsite inspections vary with the loan type, the payment history
of the borrower, and the requirements of secondary market
purchasers;
- ARM adjustment calculation. The agreement should provide a

description of conditions governing when the servicer will
calculate and notify the borrower of adjustments to the loan and
payments per the contractual agreements of the note;
- Repurchase of rights. Written documentation should exist

describing the terms and conditions with which the credit union
can cancel or buy back the servicing rights;
- Resale of rights to a third party. If the credit union sells loans to

a secondary market investor, the contract will contain a
provision of approval for the sale of servicing rights to a third
party. This protects the credit union's interest in the loan from
involvement by inadequate servicers; and
- Penalty provisions for noncompliance. Noncompliance with

any of the above provisions should trigger penalties outlined in
the servicing agreement.
Page 1OA-14
Escrow Escrow accounts accumulate funds to pay taxes, assessments,

Accounts insurance premiums, and other charges that could affect the credit
union’s first lien position. The servicer’s responsibility involves
maintaining escrow accounts and adequate records to document (1)
each account, its activity and current balance, (2) the prompt payment
of bills, and (3) required reporting to appropriate government and non-
government agencies. Regulation Z contains specific guidelines for
escrow accounts.
Foreclosures Once the credit union determines the member either cannot or will not
bring the loan current and make the required payments, it should
consider foreclosure. Servicers’ policies should comply with secondary
market requirements. Policies and procedures should consider
provisions of the mortgage, applicable state or local laws, requirements
of a loan insurer, and the best interests of the credit union.
Policies and procedures should address the following:
0 Onsite inspections. Property location, crime rate in the area,

occupancy status, and loan owner requirements determine the
frequency and extent of onsite inspections;
0 Property maintenance. The policies and procedures should ensure

the property physically remains in salable condition. This can
include lawn mowing, trash removal, snow removal, winterizing,
etc.;
Acceptable timeframes for foreclosure action. Legal counsel

should address this issue. Generally, servicers should start
foreclosure promptly after three full payments are past due on a
first mortgage and after two full payments are past due on a second
mortgage. They should immediately start foreclosure of abandoned
or empty property;
0 Insurance. Filing of needed claims with a mortgage insurer, if

appropriate (e.g., PMI) and ensuring the credit union obtains
insurance on foreclosed property; and,
Page 10A-15
EXAMINER'S GUIDE
0 Pursuing deficiency judgments. The credit union must consider

local laws restricting such action, the costs involved, potential
delay in foreclosure procedures, collectibility of judgment, and the
requirements of the secondary market.
A credit union foreclosing on secured contaminated property should

determine if a liability exists under the Comprehensive Environmental
Response, Compensation, and Liability Act (CERCLA.) CERCLA
facilitates the cleanup of hazardous waste sites. The mere threat of a
hazardous substance release can invoke liability under CERCLA,
which covers environmental hazards in the air, water, and soil. Legal
guidance should help them determine the appropriate course of action.
Once the credit union completes foreclosure, it should account for the
property as other real estate owned (OREOs) in accordance with
generally accepted accounting principles (GAAP.)
Internal A major purpose of internal controls is to avoid fraud and

Controls, embezzlement. Separation of duties in the three phases of the mortgage
Segregation of lending process (taking the application, processing, and underwriting)
Duties
decreases the risk of fraud. If the credit union cannot provide for
adequate segregation of duties using its own staff, it should consider
contracting out enough of the activities so that proper separation of
duties occurs. A contractor can perform any or all of the three phases.
Independent A quality control program uses a sample of loans selected randomly by

Quality Control the quality control department. The quality control department audits
the sample to determine proper collateralization according to the
policies and procedures of the credit union and the regulatory
authorities. Servicers must correct deficiencies uncovered during these
reviews. Credit unions that sell loans to the secondary market must
ensure their quality control program meets secondary market
requirements.
Asset/Lia bility The assetlliability management (ALM) program must address liquidity
Management and ALM to maximize the gross spread and control interest rate risk
Page 10A-16
(IRR.) The AssetLiability Management chapter provides additional

information.
Adjustable Credit unions can reduce interest rate risk associated with mortgage
Rate Real lending by offering adjustable rate loans. However, adjustable rate
Estate Loans loans carry their own problems, including:
Lower yields, caused by market rates materially lower than those of

fixed rate mortgages;
Low "teaser" rates to attract borrowers (caution: the secondary
market will not accept rates discounted more than 300 basis points
below market);
Index adjustments too far apart. The longer the adjustment period,
the greater the lag;
Adjustment caps too low. A low cap may keep the rate too low for
the market, and too low to cover the credit union's costs;
No floor rate. The credit union should establish a floor rate that
will cover their costs;
Use of an inappropriate index. Nonstandard indices affect salability
and may result in poorer performance;
Default among borrowers when rates adjust upward. Inability of
borrowers to afford the higher payments may lead to more defaults;
and,
Penalties. Mistakes in calculating adjustments to rates may result in
penalties.
Subordinate Subordinate, often second, mortgages allow borrowers to use a portion

(Second) of the equity in their homes to secure borrowed hnds. The NCUA
Mortgages Rules and Regulations do not prohibit third or fourth mortgages, but
credit unions must carefully evaluate these for increased risk.
Tax laws allow borrowers to deduct interest on loans secured by their

homes under certain conditions, so obtaining a mortgage loan often
offers a tax advantage over a consumer loan.
Second mortgages, also marketed as "Home Equity Loans," include the

following types:
Page 10A-17
EXAMINER'S GUIDE
0 Open-endclosed-end. An open-end loan is either a line of credit

(in which the credit union pre-approves advances at the time of
application) or a loan where each additional advance requires
reapplication and approval. Closed-end refers to the common type
of standard second mortgage with set principal and term.
0 Fixed rate/adjustable rate. Either open-end or closed-end second

mortgages can have a fixed or an adjustable interest rate.
Adjustable rate second mortgage loans can have all the features of
an adjustable rate first mortgage: index, premium above index
(e.g., "index plus two percentage points"), annual and lifetime
caps, floors, etc.
A well-established market for second mortgages exists, so credit

unions should use the standard documentation and practices in setting
their own requirements.
Home Equity A Home Equity Line of Credit (HELOC) is a mortgage that does not
Lines of Credit require reapplication and approval for each advance. A HELOC carries
an adjustable interest rate, usually adjustable monthly (with Prime Rate
changes) or quarterly (per contract terms.)
In general, credit unions process and underwrite HELOCs in the same

way as second or subordinate mortgages, with the following
differences:
0 Note and mortgage. Credit unions use special note and mortgage
instruments for HELOCs. Standard secondary market documents
for applicable parts of a HELOC loan file (e.g., mortgage, deed,
title opinions) are recommended.
0 Consumer regulations. The credit union must comply with all

applicable consumer regulations. See the Consumer Compliance
chapter for further information.
0 Legal considerations. Legal opinions specifying the documents

used to comply with applicable state and federal regulations should
remain on file in the credit union.
Page 10A-18
Creditworthiness. Credit union staff must analyze the borrower's

creditworthiness periodically throughout the life of the loan.
Loan-to-value (LTV) ratio limits. Credit unions should establish

LTV limits. For conventional loans, the maximum LTV
permissible should not exceed 80 percent of the lower of the
appraised value or sales price unless the borrower obtained private
mortgage insurance (PMI.) Credit unions should require borrowers
to obtain the PMI from a company acceptable to the credit union
and to established secondary markets. The LTV for government
insured loans may not exceed the applicable FHA or VA
guidelines. In declining real estate value markets, credit unions
may require periodic appraisals for some properties. Ideally, credit
unions should have the ability to trace property value statistics.
Falling market values may require a reassessment of loan limits
and the invoking of "Escape Clauses" allowed by the Federal
Reserve Board to reduce the line of credit.
0 Title insurance. As with other second mortgages, if the borrower

can demonstrate title insurance outstanding, the credit union may
choose to waive title insurance. However, without evidence of first
mortgage title insurance, credit unions should require title
insurance on home equity loans (assuming a sufficient loan
amount.) The home equity loan should have a higher priority lien
than an existing line of credit.
0 Cash advances. The credit union's internal control programs should

include tests of abuses of the equity line of credit. Equity lines of
credit should not pay other in-house obligations. Establishing cash
advance minimums discourages borrowers from using the line of
credit for daily living expenses.
Interest rate index. Credit unions must use publicly disclosed

indices to establish the borrowing rate, not an internal cost of funds
index. The index should be specific, such as the Prime Rate as
published in the Wall Street Journal on a specific day.
Page 10A-19
EXAMINER'S GUIDE
Loans Secured Mobile home loans secured by property may qualify as a real estate or
by Mobile
..
consumer loan, according - to each state's laws. Credit unions should
Homes and familiarize themselves with their applicable state laws. In many cases,
Real Estate
title insurance companies will not include the value of the mobile
home in their policy unless the borrower removes the wheels and
tongue and places it on a permanent foundation. Also, some states
require the same to qualify for homeowner's insurance.
Insured - §701.21(e) of the NCUA Rules and Regulations permits credit unions
Guaranteed to grant loans secured by the insurance or guarantee of, or with an
Loans advance commitment to purchase the loan by, the federal government,
a state government, or any agency of either. The law, regulations, or
program under which the insurance, guarantee, or commitment is
provided specifies the maturity, the terms, and conditions, including
rate of interest, for making these loans.
Loans insured by the Federal Housing Administration (FHA) and loans

guaranteed by the Veterans Administration (VA) are the most common
types of loans that credit unions grant under this authority. Both types
of loans help reduce the credit risk.
Only credit unions designated as "FHA-approved mortgagors'' may

originate loans under an FHA insurance program, and those
functioning as "supervised lenders" may originate VA loans. Most
credit unions should qualifl.
These programs usually allow a borrower to purchase a home with

little or no down payment. While the insurance or guarantee does not
prevent a loss to the credit union, it usually provides the same
protection that a large down payment from the borrower provides.
FHANA loans are more liquid than conventional mortgages, since

both real estate and the government insurance or guarantee contract
secure the loans. Additionally, credit unions may pool FHA and VA
loans into Government National Mortgage Association (GNMA) pass-
through securities. This pooling ability helps lower potential liquidity
risk.
Page 10A-20
Auto-Equity Changes in the tax laws severely restricted the deductibility of

Loans consumer loan interest paid by taxpayers. Lenders responded to these
changes by creating “auto-equity” loans. Credit unions offering these
consumer-purpose loans (generally for automobile purchases) take title
to the automobile and place a lien on the member’s real property. This
action may make the loan interest tax deductible for the member
(credit unions should provide members with a notice to consult a tax
professional regarding deductibility of interest paid on the loan.)
Most credit unions underwrite these loans using consumer loan

guidelines, rates, and terms. Credit unions take the real property lien
purely as an abundance of caution and to possibly make the interest
paid on the loan tax deductible for the members. The credit unions
must comply with the applicable disclosure requirements for real estate
loans, including recision requirements.
Construction Construction loans are high-risk loans that require sophisticated

Loans underwriting and administration. Construction loan policies should
establish limits compatible with the credit union%size. The limits
should integrate construction lending into the overall ALM plan.
Credit unions should hire or contract with loan processors and
underwriters trained and experienced in construction lending. NCUA
Letter to Credit Unions No. 124 (June 1991) provides credit unions
with real estate lending guidelines, which included information on
residential construction loans. Generally, there are four types of
construction loans:
Loans to a developer to complete a commercial building such as a

shopping center, office building, hotel, or apartment building;
0 Loans to a developer to finance residential construction made on a
speculative or “spec1’basis (i.e., homes built to sell later in the
general market);
Loans to a general contractor to finance single homes to persons
who may or may not have obtained prearranged permanent
financing; and,
Loans to an owner for financing the construction of the owner’s
primary residence (whether or not the owner acts as the general
contractor.)
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EXAMINER'S GUIDE
The first three loan types are member business loans if they exceed
$50,000. When owners act as general contractor, the credit unions
must have tight controls to ensure construction progresses as planned.
The major concerns involved in construction lending are:
Failure of the builder to produce the anticipated product as

contracted;
Threat of prior or intervening liens placed on the mortgaged
property;
Unreliable market analysis resulting in either an unmarketable or
difficult-to-market project; and,
0 Inadequate funding for completing construction.
The following are possible unsafe and unsound operating practices:
Disbursing funds in advance of construction progress. This could

result in the credit union not having sufficient undisbursed funds to
ensure project completion;
Approving loan agreements, which do not include precautionary

measures, to avoid the filing of mechanics' liens or stop notices.
Mechanics' liens precede mortgage liens and stop notices can
cause costly delays in construction;
Approving loans for speculative or investment projects without (1)

evaluating and approving feasibility studies, or (2) obtaining an
independent appraisal of land value;
Approving loans to investment borrowers without considering (1)

their past performance records on similar projects, and (2) the
proposed marketing program for the planned project;
Approving loan agreements that do not include provisions for

inspecting the construction's progress. Credit unions should
disburse funds for labor and material according to progress of the
project;
Approving construction loans without prior review of builder's cost

estimates to determine the accuracy and reasonableness of the
estimates;
Page 10A-22
0 Disbursing construction funds without supporting inspection

reports;
0 Approving loan agreements that do not require prior approval for

changes in plans and specifications;
0 Failing to segregate construction loan appraisal, inspection, and

disbursement functions; and
Granting loans to builders or developers with insufficient equity in

the project. §723.3(b) of the NCUA Rules and Regulations requires
35 percent equity.
Land Loans Loans collateralized by either raw acreage or improved property

(having sewers, utilities, curbs, etc.) often contain high risk because of
volatile land values and limited marketability compared to other real
estate. Land loans usually require the following additional documents:
0 Appraisal, Survey, and Zoning Requirements. When determining

the soundness of the loan, the appraisal should consider the size of
the property, the zoning requirements, the stated highest and best
use of the land, access to highways, etc. A credit union should limit
the LTV to no more than 60 - 70 percent of the appraised value of
the land. Some experts limit the LTV to 50 percent. This will
depend on the quality of the land, planned use of the land, and how
soon owners plan to develop it;
0 Agreement that parties require credit union approval before making

any improvements to the property; and,
Title search and insurance. Credit unions should periodically

inspect unimproved property to ensure the borrower does not make
changes without the credit union’s knowledge.
Member A member business loan includes any loan, line of credit, or letter of
Business credit (including any unfunded commitments) where the borrower uses
Loans the proceeds for a commercial, corporate, other business investment
Page 10A-23
EXAMINER'S GUIDE
property or venture, or agricultural purpose. NCUA Rules and

Regulations 5723.1(b) lists the exceptions to this general rule.
Credit unions must separately identify member business loans in their

records and in the aggregate on their financial reports and 5300 Call
Report. Many credit unions do not properly identify their member
business loans. A review of the loan collateral and purpose codes can
help identify potential member business loans. Reviewing reports on
amortization, new funds advanced, extensions and loans granted in
excess of $50,000 may also assist in identifying these loans.
Policies and Member business lending requires special skills in underwriting,

Procedures servicing, and collecting. Credit unions engaged in member business
lending must use the services of an individual with at least two years
experience in business lending. Credit unions must have the expertise
to monitor the financial condition of member-borrowers through
periodic receipt and analysis of financial data, when appropriate and
necessary (e.g., open-end member business loans.)
Member business lending programs often affect liquidity and interest

rate risk. Credit unions involved in this type of lending must have
adequate ALM policies and procedures before the credit union starts
making these loans. The commitment to the borrower may involve a
long-term business relationship, even though the actual loan term is
short. For example, an agricultural operating loan generally involves a
long-term commitment to fund the annual operations, while the
individual loan may mature in one year or less.
To adequately address transaction and compliance risks, credit unions

must document internal controls, policies, practices, and procedures.
This documentation should include the types of loans granted, copies
of forms used, and any other pertinent information.
Underwriting The underwriting process should include an evaluation of the character

and integrity of the borrower, including the borrower's ability to
manage the business, repay debt, and accumulate capital in the
business. The credit union should also assess the condition of the
Page 10A-24
industry in which the borrower operates, particularly as it affects the

ability to repay.
The emphasis in underwriting member business loans shifts from the

individual to the financial soundness of both the business and the
member requesting the loan. To support their analysis of businesses,
credit unions can use (1) commercial credit reports (e.g., Dun and
Bradstreet), (2) individual credit reports, (3) balance sheet and income
and expense statements, (4) cash flow statements, and (5) ratio
analysis. Whenever a credit union requires a personal guarantee on a
loan, it must evaluate the guarantor's financial strength. Some tools for
the analysis include:
0 Cash flow analysis. A credit union should only make the loan if the
borrower has cash flow projections based on actual cash flow data.
Many small businesses have trouble obtaining adequate and
reliable cash flow information. Credit unions should not accept
cash flow assumptions without data to show they are realistic.
Borrowers must provide evidence they have sufficient hnds
available to service the debt.
The credit union should obtain tax returns and financial schedules
of both the member and the business to properly analyze the cash
flow statement. A quick test for cash flow is to add back to the
profit-and-loss data of the business (net income) any non-cash
expenditures (such as depreciation, adjustments to accounts
receivable, etc.) and relate a positive resulting figure to the
member's ability to cover loan payments.
0 Net worth analysis. In addition to reviewing cash flow, the credit

union should evaluate the strength of the business. One method of
measuring profitability is to divide net profit by net worth, which
results in the owner's return on investment.
Net worth is the equity or retained earnings of the business and

represents the borrower's cushion before bankruptcy or insolvency
occurs. Borrowers can distort net worth by overstating assets or
understating liabilities. While borrowers often overvalue their
assets, they can also understate liabilities both on their personal
Page 10A-25
EXAMINER'S GUIDE
and business financial statements. A borrower must supply

supportable financial data to the credit union.
0 Collateral analysis. The underwriting process must include a

determination of the value, liquidity, and lien status of the
collateral. Prudent lending requires the borrower to have equity in
the assets securing the loan. The credit union's member business
loan policy must establish guidelines for the maximum LTV the
credit union permits for various types of collateral, while meeting
the minimum regulatory requirements. When establishing these
values, the credit union must keep in mind the forced sale of
collateral generally brings a minimal return in relation to the value
of the assets of a viable business.
Considering the high percentage of new businesses that fail, the

credit union must carefully analyze collateral and cash flow. If the
borrower uses inventory as collateral, all the procedures discussed
later in this chapter concerning floor plan loans apply. However,
the forced sale value of inventory in process may cover only a
fraction of the value of the finished product.
0 Financial analysis ratios. Credit unions should analyze at least

three years worth of data from financial statements before granting
a loan. They should perform ongoing analysis after granting the
loan. Forward, as well as historical projections are critical to sound
financial analysis. Examples of basic capital and liquidity ratios
can be found in Appendix 1OC - Member Business Loan Financial
Ratios. Credit unions should use these ratios and, if necessary,
establish additional ratios to analyze loans.
Credit unions may use published ratios relating to various

industries as a standard for comparison (e.g., the Robert Morris
ratios.) The credit union should maintain copies of the particular
industry's standard ratios.
Documenta- Documentation for a member business loan also must include proper
tion signatures from the parties to the transaction (those individuals
permitted to borrow under the FCUAct, FCU Bylaws, and the NCUA
Rules and Regulations.) 8723.7 of the Regulations require the credit
Page 10A-26
union not grant member business loans without the personal liability
and guarantee of the principals, except where the borrower is a not-for-
profit organization, as defined by the IRS (26 U.S.C. 501.)
Lien filings often require the use of UCC documents. The credit union
must file the necessary documents with appropriate local or state
agencies, perform and document their search for prior liens, and keep
their liens current, as required by their local or state agencies. Business
assets also require proper insurance with appropriate loss payable
clauses to the credit union.
Loan covenants documenting specific conditions of the loan are part of

the member business loan note. Examples of loan covenants include
(1) frequency of providing financial reports, (2) insurance renewal
periods, (3) working capital requirements, (4) limits on owner draws,
(5) permission for periodic onsite business inspections, and ( 6 ) call
options, if the financial performance of the business deteriorates. An
attorney experienced in loan covenants should prepare the loan
agreement. Credit unions willing to take the risk of making a member
business loan must recognize they need to pay for the expertise needed
to document the loan agreements.
The credit union should know that too many covenants can expose the
credit union to possible "lender liability", if the borrower defaults.
Lender liability can also occur when a borrower becomes dependent on
a lender for a constant supply of funds.
Environmental A credit union foreclosing on secured contaminated property should

Protection determine if a liabilitv exists under the ComDrehensive Environmental
Agency (EPA) Response, Compensakon and Liability Act (CERCLA.) CERCLA
Concerns
facilitates the cleanup of hazardous waste sites. The mere threat of a
hazardous substance release can invoke liability under CERCLA,
which covers environmental hazards in the air, water, and soil.
Technically, when the credit union forecloses on the collateral, it

becomes the "owner" of the property and the EPA can hold lenders
liable for hazardous waste cleanup. However, CERCLA can exempt
parties that hold ownership primarily to protect their security interest,
Page 10A-27
EXAMINER’S GUIDE
even when foreclosure leads to actual ownership. Legal guidance

should help them determine the appropriate course of action.
Types of Examples of member business loans include investment property

Member loans, working capital advances, term business loans, agricultural
Business credit, and loans to individuals for business purposes. Some credit
Loans
unions also grant letters of credit, which examiners may find
particularly difficult to identify since they are an off-balance sheet
contingent liability.
Rental The most common type of business loan is for rental property where
Property the member obtains a credit union loan secured by an apartment
Loans building or a house, which the member then rents out. While real
estate securing a member business loan may meet the requirements for
exclusion from Part 723 of the NCUA Rules and Regulations, the
examiner should treat the loan as a member business loan for review
purposes.
When credit unions use rental income to qualify a borrower for a loan,
the credit union should include the gross rental income as part of the
borrower’s gross income (after factoring in a reasonable vacancy rate),
and the borrower’s debt should include expenses related to the
property.
Credit unions should support credit-granting decisions for rental

property by determining the property’s cash flow. For example, adding
back depreciation to net rental income provides a good estimate of
cash flow from rental property. Loan officers making rental property
loans should have sufficient expertise in the rental property area,
including a full understanding of Schedule E of the member’s tax
return.
Working Working capital is the difference between current assets and current
Loans liabilities. This type of loan provides temporary capital in excess of
normal needs. Working capital loans provide short-term funds that
borrowers repay at the end of the cycle by converting inventory and
accounts receivable into cash. Businesses engaged in manufacturing,
Page 1OA-28
distribution, retailing, and service-oriented operations use short-term

working capital loans.
Regulatory requirements and sound business practices govern the

collateral securing this type of loan. Usually, the credit union takes the
borrower's accounts receivable or inventory as collateral. If the credit
union takes inventory as collateral, the lien should include the phrase
"and proceeds thereof' since inventory converts to cash or accounts
receivable, as it is sold.
Since this type of loan is high-risk, a credit union must set financing
limits. For example, since accounts receivable collateral will rarely
bring 100 cents on the dollar in a forced sale, the credit union should
limit the loan to an amount less than the book value (e.g., 50 percent.)
In addition, credit unions should review the accounts receivable
discount terms and aging records to determine collection activity of the
business.
If the credit union takes accounts receivable as security, the loan

covenants should require the borrower to regularly check the credit
rating of the major debtors on the receivable list. The credit union
should receive a monthly aging of the accounts receivable past due and
make periodic onsite inspections to determine the accuracy of the
borrower's aging and reporting records. The credit union should also
determine if the borrower has pledged inventory against another loan
(e.g., a UCC filing search.)
When taking inventory as collateral, the credit union must perform

periodic onsite inspections to ensure the borrower maintains a reliable
inventory control system. The credit union should perform test checks
on the inventory control system to ensure the accuracy of the total
amount of reported inventory.
In all cases, credit unions should obtain quarterly profit and loss
statements (including past statements, preferably for two or more
years) from the borrower to evaluate the continued viability of the
business.
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EXAMINER'S GUIDE
Term Business Normally, members use term business loans to acquire capital assets
Loans such as plant and equipment. Regulatory requirements govern the
collateral securing this type of loan. Due to the extended loan period,
term loans contain more interest rate risk than do short-term advances.
Because of the greater risk, credit unions should require amortization
payments. Loan agreements will also contain restrictive covenants
(conditions agreed to by the borrower) for the life of the loan.
Ag ricuItural Agricultural loans range from mortgages on real estate to equipment,

Loans livestock, growing crops, operating loans, or personal loans. A credit
union making farm real estate loans must take into account various
factors that may not occur in other real estate loans. For example,
credit unions making farm loans should (1) value not only acreage, but
the productivity of those acres; (2) consider erosion and wastage along
with fertility, since repayment may occur over an extended amount of
time; and (3) look to the farm's productivity over a series of years as
the source of repayment. Changes in price levels affect net worth.
To ensure repayment of the loan, credit unions should determine the

agricultural operation earns sufficient income to pay taxes, personal
living expenses (if applicable), operating expenses (including crop and
herd insurance, if required), and reasonable allowances to maintain the
productivity of the land and income flows. A farmer or rancher must
demonstrate managerial efficiency by maintaining operating costs
consistent with the productive unit type the borrower offers as security.
Some owners, or farm or ranch managers, operate farms or ranches
inefficiently because they economize too much in the use of labor-
saving machinery, while others invest in more mechanization than the
farm income can support.
If the amount of agriculture loans represents a significant risk to the

credit union examiners can use the following questions as guidelines
when evaluating internal controls for agriculture loans:
Livestock loans:
- Does the credit union require inspections at the time it makes

livestock loans? Does the credit union require the borrower to
provide proof of ownership at that time?
Page 10A-30
Does the credit union require inspectors to properly date and

sign the inspection report?
Does the inspection report note the condition of the animals?
Does the credit union require periodic inspections when
appropriate for the type of livestock loan?
Has the credit union made proper notification to and reviewed
with appropriate brand inspection or recording offices to ensure
the borrower has proper title to the livestock?
Is the brand registered with the appropriate local or state
agencies?
Is the brand registered in the borrower’s name?
Has the credit union established a tickler file to ensure the
borrower reregisters the brand every nth year as required by
local or state agencies?
Does the credit union file security agreements with appropriate
local and state authorities?
Does the credit union require assignment of milk check
agreements on dairy loans?
0 Crop loans:
- Does the credit union require inspections of growing crops

before it advances funds?
- Does the credit union require borrowers to obtain crop
insurance, where appropriate?
- Does the credit union closely monitor disbursements to ensure
the borrower channels loan proceeds into the farm operation
and uses the proceeds as intended?
- Are disbursement checks made out jointly to the borrower and
vendor?
Letters of A letter of credit substitutes the creditworthiness of the credit union for
Credit that of the individual or corporation. Credit unions may earn a fee for
issuing a letter of credit. Most credit unions do not offer them.
Credit unions disclose letters of credit, which are off-balance sheet

contingent liabilities, using footnotes to the financial statements. When
credit unions fail to disclose letters of credit, examiners may detect
them through fee income spikes occurring in a single month.
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EXAMINER'S GUIDE
Although the credit union disburses no funds when it approves a letter

of credit, sound internal controls for member business loans require
lenders to treat a letter of credit like a funded loan (i.e., if the member
cannot service the debt, the collateral must be liquid.)
Two types of letters of credit are (1) the commercial letter of credit,
and (2) the standby letter of credit. Often, a commercial letter of credit
finances the sale of goods between a buyer and seller. The seller ships
the goods to the buyer and submits an invoice. To avoid risk of
nonpayment for the goods, the seller may require the buyer to obtain a
letter of credit. Commercial letters of credit, secured by cash deposits,
pose little risk to an institution as long as the credit union receives
proper documentation from the beneficiary (seller.)
A standby letter of credit represents an irrevocable commitment to pay

if the member defaults on an obligation. When issuing standby letters
of credit, credit unions should determine that adequate collateral
secures these letters of credit. Application forms should automatically
convert to collateralized notes when members draw upon their letters
of credit. Standby letters of credit have many uses. A request for a
demand for payment of a standby letter usually signals something is
wrong. Nonperformance or default that triggers payment of a standby
letter of credit signals financial weakness, whereas payment under a
commercial letter of credit suggests a normal business transaction.
Floor Plan Floor plan lending, a form of wholesale or inventory financing,

Loans finances items for dealers, including automobiles, mobile homes,
boats, large home appliances, furniture, television, and stereo
equipment. Under a written contract between the credit union and the
dealer, a specific piece of equipment collateralizes each loan advanced.
As the dealer sells a piece of collateral, the contract requires the dealer
to repay those funds advanced for that collateral sold. A common
policy requires dealers to invest 10 to 20 percent of their own funds.
Credit unions rarely engage in floor plan lending, which is specialized

lending with above-normal risks. Loan officers working in the area of
floor plan lending require special expertise.
Page 10A-32
This type of financing usually involves the use of a trust receipt. The
written contract between the credit union and the dealer specifies the
credit union will release to the dealer title to a specific piece of
collateral sold with the stipulation the credit union will hold title to
such collateral in trust until time of sale. The contract usually gives the
dealer the right to sell the inventory, but normally at not less than the
"release price." The credit union should request the dealer to authorize
the credit union to periodically inspect the inventory, examine the
dealer's records, and upon any default by the dealer to declare a
forfeiture of the dealer's interest in the inventory. The credit union can
verify inventory for reasonableness against tax forms.
To reduce the risk involved in this type of financing, the credit union
should ensure prompt repayment by frequently inspecting the dealer's
inventory (to determine exactly which units the dealer has sold), record
inspection dates, the name of the inspector, and an itemized list of
collateral.
Floor plan financing contracts should also provide for partial

repayments on unsold inventory. For example, contracts frequently
require the dealer to pay down the invoice price by 10 percent after 90
days and then make a 5 percent partial payment each month thereafter.
Under such a plan, the credit union would require the dealer pay in full
the note financing any units not sold after one year. This plan
encourages inventory turnover and helps the credit union avoid
financing out-of-date inventory.
Credit unions should require periodic financial statements from the

dealers, monitor the dealers' financial position, and address any over-
leveraging that may occur. Problems result when a dealer floor plans
inventory with several lenders and uses the proceeds from the sale of
the inventory for purposes other than to repay the floor plan loan.
Examination The review of the member business loan portfolio could document the
Guidance credit unions compliance with:
0 Member business loan requirements of Part 723; and,

0 Loan maturity limits of §701.21(~)(4).
Page 10A-33
EXAMINER'S GUIDE
Examiners may complete the Business Loan questionnaire, which

documents (1) whether the credit union complies with the NCUA Rules
and Regulations, and (2) whether safety and soundness concerns exist
in the credit union's member business lending practices. Examiners
may also benefit from developing continuing workpapers for tracking
member business loans from one examination to the next.
Examiners should report on the status of member business lending in

credit unions whose member business loans exceed regulatory limits
specified in 5723.16 (the aggregate of member business loans plus
unfunded commitments equal the lesser of 1.75 times the credit
union's net worth or 12.25 percent of the credit union's total assets.)
SBA Loans The Small Business Administration (SBA), an independent agency of

the federal government, guarantees up to 90 percent of the principal
and interest on loans made by credit unions to small businesses
meeting prescribed eligibility standards. In determining the $50,000
member business loan threshold, credit unions should consider only
the amount of the loan not guaranteed by SBA.
Participation Federal credit unions may participate with others in loans to credit
Loans union members, subject to the provisions of 5701.22 of the NCUA
Rules and Regulations. Participation loans may provide additional
security to an investor, since the credit union would share in a portion
of any loss.
The contract between the investor and the credit union may require the
credit union to assume the majority of the risks in the event of a
default. Such a contract may affect the adequacy of the Allowance for
Loan and Lease Losses account. Sometimes credit unions enter into
such transactions to avoid booking losses on a sale. If a third party
with whom the credit union participates receives a higher rate of return
on its investment than the credit union, examiners should carefully
review the transaction to determine the credit union properly accounts
for the transaction.
Following are possible unsafe and unsound operating policies and

practices in loan participations:
Page 10A-34
-
LOAN TYPES APPENDIX 10A
0 Purchase of loans without investigation of borrowers' credit

positions, the condition of security properties, and the adequacy of
appraisal reports;
0 Purchase of unacceptably high risk loans to obtain purchase

discounts or net yields above current market averages;
0 Sales of high-yield loans and replacement of these loans with

lower-yield loans;
Sales of loans at a time when no current or projected demand for

loanable funds exists; and,
0 Participation sales only for creating income from a yield

differential, a particularly risky practice under the condition
described immediately above.
Purchase, Credit unions may purchase, sell, or pledge, in whole or in part,

Sale and eligible obligations and loans in accordance with $701.23 of the NCUA
Pledge of Rules and Regulations.
Eligible
Obligations Review procedures could include these additional steps:
Conformance with all applicable parts and established limits of

$701.23;
0 Conformance of accounting procedures with GAAP, as applicable;
0 Adequacy of reporting and collection practices and procedures;
0 Existence and proper endorsement of notes and collateral
documents; and
Soundness of the loans' value.
Stock Credit unions sometimes offer loans collateralized by stock, often in

Secured conjunction with a sponsor company, to facilitate sponsor-employee
Loans stock programs. Securities listed on the New York Stock Exchange
(NYSE), American Stock Exchange (AMEX), or NASDAQ usually
have a ready market. In most instances, credit unions should not make
loans secured by stocks not listed on a national exchange, since these
Page 10A-35
EXAMINER'S GUIDE
loans can substantially increase credit, transactional, liquidity, and

reputation risk.
The Federal Reserve Board's Regulation U (12 C.F.R. $221.2)

provides an in-depth definition of a margin stock. In general, a margin
stock is an equity security. Credit unions must adhere to both the
margin and reporting requirements set by Regulation U. Credit unions
that make loans to purchase securities (purpose loans) or make loans
secured by securities must familiarize themselves with the
requirements of Regulation U. Credit unions must also advise
members about Regulation X, which requires borrowers in securities
transactions to comply with margin regulations. These regulations help
curb excessive credit in the securities market.
Regulation U stipulates, in part, that if a credit union extends credit of

$200,000 or more during a quarter (or has total credit outstanding at
any time during the quarter of $500,000 or more), secured by collateral
that includes any margin security (regardless of the purpose of such
loans), it must register by filing Federal Reserve Form FR G-1 with the
district federal reserve bank. Regulation U also requires all registrants
file an annual summary recap, FR G-4. The Federal Reserve forms are
located at the FRl3 website:
www.federalreserve..gov/boarddocs/reportforms/
A currently registered credit union that has not extended any credit
secured by margin securities during any six month period and that does
not have more than $200,000 of such credit outstanding during that
period is eligible for deregistration (using form FR G-2, Deregistration
Request.)
Loan Policy Credit unions should cover the following areas in their stock secured
and Procedure loan policy:
Types of acceptable stocks the credit union will accept for

collateral (e.g., stock in the sponsoring company only, or stock
listed on one or all of the major exchanges);
Page 10A-36
0 Evaluation of the stock price, at the date of the loan disbursement,

as well as periodic evaluations of the stock value;
0 Loan to value limitations (margin.) Since stock values can

fluctuate, credit unions should allow some margin in case of a
reduction in stock value (e.g., 60 percent of current value); and,
0 Stop loss provisions. The credit union should adopt procedures to

liquidate the stock to satisfy the loan in the event the value of the
underlying stock declines below an established loan-to-value ratio.
Required Credit unions making stock secured loans should have the following
Documents documentation:
0 Note and security agreement. Consumer loan documents generally

do not suffice for perfecting stock security interest. Credit unions
often use a special note and security agreement designed for stock
secured loans. If applicable, the co-owner of the stock must sign a
third-party pledge agreement when the pledge is not part of the
security agreement;
0 Stock assignment forms. A stock assignment form giving the credit

union the right to sell the stock, if necessary, must identify the
name as it appears on the stock certificate and the stock certificate
number. A credit union employee must witness the assignment.
Sound internal controls require that stocks and assignments remain
under dual control;
Purpose statement, Form FR G-3. Credit unions must execute this

form on all loans secured by margin securities extended after the
credit union becomes subject to the registration requirements. The
form, which the borrower and credit union must sign, prevents
borrowers from using a false purpose statement to obtain funds for
purchasing margin securities. The credit union must retain the form
for at least three years after the borrower pays off the loan;
0 Collateral tracking. The credit union must document and verify the
number of shares and, as applicable, certificate numbers for stock
received. Credit unions must implement an audit procedure to
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EXAMINER’S GUIDE
periodically audit stock loans, their current balance, and the

adequacy of the collateral’s value as follows:
- Safekeeping receipts. Credit unions should issue a safekeeping

receipt to the member to document receipt of the actual stock
certificates. If the stock is in two names, the credit union
should issue only one receipt to prevent one party from
claiming the certificate without the knowledge of the other;
- Book-entry stock registration. In some cases, the member may

not physically possess the stock, but a trustee may hold the
stock in book-entry electronic format. Procedures must state
what documentation the trustee must maintain to identify the
stocks pledged as collateral for a loan; and
- Stock ownership. The credit union must assure the physical

stock certificates exist in the member’s name, not some other
or street name. However, book entry stock registrations are
held in street name;
0 Default sale. Credit unions must adopt procedures to specify the

conditions that would result in liquidation of stock collateral (e.g.,
default for past due payments or when the stock value declines.)
When the value of stock falls below an established loan to value,
the credit union must contact the member in writing and inform the
member of the options available to address the collateral deficiency
(e.g., paying down the loan or providing more collateral.)
NCUA Some credit unions purchase loans from liquidating credit unions
Guaranteed under the terms of a contract with the NCUA Board on behalf of the
Loans National Credit Union Share Insurance Fund (NCUSIF.) Some
contracts state the share insurance fund will repurchase a specified
amount of loans within a specified time if the credit union cannot
recover from the borrowers. The examiner should review the terms of
the contract to determine the credit union complies with those terms,
giving special attention to the credit union’s accounting for payments
received on the loans since contract provisions often differ.
Page 10A-38
The examiner also may need to evaluate the loans for the feasibility of
an early settlement of the loan guaranty when both NCUA and the
credit union would benefit from an early settlement (e.g., in cases of
poor performing loans where the credit union needs more flexibility to
develop a specific workout strategy.)
Indirect Indirect Dealer Financing Programs (IDFPs) allow borrowers to make

Dealer a purchase and obtain financing at the same location. IDFPs often
Financing apply to new and late model automobile loans; however, the concepts
Programs discussed apply to all types of indirect financing or point of sale
lending.
A credit union should evaluate the stability of the dealership before

entering into an IDFP business relationship. A credit union should
investigate dealerships by (1) obtaining a Dun and Bradstreet report on
the dealership, (2) contacting the applicable department of motor
vehicles and the Better Business Bureau, and (3) analyzing the
dealership’s audited financial statements. Even after establishing the
program, the credit union should cautiously select dealers and continue
to review dealer selection.
In an IDFP, the automobile dealership realizes additional profit by

charging a flat fee for referring loans to the credit union, or by
charging the buyer-borrower an interest rate higher than the credit
union’s lobby rate (rate differential.) Rate differentials in excess of
three percent indicate the dealership may be taking advantage of the
credit union’s members.
While the dealer initially determines the existence of credit union

membership or eligibility for membership for a prospective borrower,
responsibility for membership eligibility is the credit union’s first
consideration before beginning the loan approval process.
Before initiating an IDFP, the credit union should have in place:
0 A written business plan that incorporates the aspects of the IDFP

into appropriate areas of the credit union’s operation;
0 A sound overall lending program;
Page 10A-39
EXAMINER'S GUIDE
0 Documentation of management's due diligence, including a formal

costhenefit analysis, for the proposed IDFP;
0 An asset-liability management strategy that includes specific

provisions for the IDFP;
0 Detailed IDFP lending policies and procedures;
0 Experienced IDFP lending management and staff;
0 A comprehensive "dealership agreement'' that delineates the rights,

duties, and obligations of both the dealer and the credit union;
0 A legal opinion on file that addresses the IDFP in general and

specifically (1) the legality of the dealership agreement and loan
documentation, and (2) applicable state and federal consumer
compliance laws (Truth in Lending Act, Credit Practices Rule, Fair
Credit Reporting Act, etc.);
0 A strong internal control program that safeguards against contracts

that may take advantage of members. The rapid growth and
competitive pace of IDFPs may result in dealers using undue
pressure tactics; and,
0 A strong collection department with expertise in repossessing and

disposing of vehicles.
Policies and Formal IDFP policies and procedures should, at a minimum, address:
Procedures
0 Membership eligibility;
0 Definition of terms;
0 Lending requirements, including:
- Obtaining legal opinions on loan documents and applicable

consumer laws;
- Qualifications for the lending staff; and
- Limitations on aggregate amounts loaned through the IDFP;
Page 10A-40
Dependable line of credit to avoid discontinuing the program

during times of tight liquidity;
Qualifications of dealerships (e.g., financial, experience, longevity,

and ongoing analysis of dealer profitability);
Limitations on dealers and dealerships;
Internal controls;
Monitoring procedures, to review by dealer:
- Number of applications processed;

- Number and amount of loans approved, conditioned, and
rejected;
- Number and amount of loans booked; and
- Delinquency, repossessions, and charge offs;
Method of determining rate differential or flat fee (credit unions

should amortize rate differentials over the life of the loan or when
the loan is paid off, whichever is sooner);
Dealer contracts, including a legal opinion on such contracts;
Auditing procedures for the dealer's reserve accounts and payouts;

and,
Marketing strategies aimed at maintaining a good relationship with

the dealers.
Potential The following are a few of the problems credit unions may encounter
Problems in an IDFP:
Unless the credit union has a competitive rate differential (or flat
fee) structure, dealers may only forward high-risk loans, thereby
increasing credit and transaction risk;
Without adequate preparation and control, the increased loan

volume could overrun the loan department resulting in unsound
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EXAMINER’S GUIDE
underwriting decisions, again increasing credit risk and possibly

liquidity risk;
0 The increase in automobile loans could overtax the collection

department with increased delinquencies and repossessions, thus
increasing transaction and credit risks;
0 The dealer’s involvement may increase the credit union’s potential

for making a loan to a non-member or ineligible member, thus
increasing reputation risk;
0 The Holder-in-Due-Course provision, which creates a contingent

liability to the credit union, applies due to the business relationship
between the credit union and dealership. Since the degree of risk to
the credit union depends on the financial stability and business
reputation of the dealers involved, the credit union should ensure
that the dealership agreement includes a recourse (or
indemnification) agreement, which limits the credit union’s losses
in the event of a claim under the Holder-in-Due-Course provision;
The dealer’s buy rate or the flat fee paid to the dealer diminishes
the credit union’s profit margin. Constant monitoring of the
costhenefit relationship provides the board with important
information for determining the IDFP’s viability;
Credit unions may lose fee income when the dealer sells loan
protection, disability, and other types of insurance to members. The
codbenefit analysis should include the effect of lost opportunity
fees;
0 Credit unions with IDFPs that take members or business away

from other area credit unions may experience strained relations
with those credit unions, affecting reputation risk;
Some members may become disgruntled to learn they are paying

higher interest rates or insurance prices through an IDFP than other
members pay who deal directly with the credit union. The credit
union’s marketing program should keep the membership informed
of current lobby rates; and,
Page 10A-42
0 The endeavor could result in a loss to the credit union if a

substantial number of IDFPs fail; however, the credit union can
minimize the risk of loss or failure if it takes appropriate initial
steps before getting involved in an IDFP.
Warning Signs The following items may evidence the credit union’s lack of control
over the program:
0 The credit union approves more than 75 percent of the loans

processed;
0 The credit union places full reliance on the dealer to obtain credit
checks and credit reports;
0 The dealer, not the credit union, accepts the borrower’s loan
payments;
The dealer makes payments on behalf of the borrower, a practice

that could potentially disguise past due accounts;
0 The member-borrower may apply for the title, which could result
in an improperly recorded lien;
The dealer finances the down payment (through dealer incentive,

inflated or fraudulent trade-in, or purchase price, etc.) resulting in
the member having no equity in the collateral;
The credit union initiates or permits continuous overdrafts in the

dealer reserve or holdback accounts;
The IDFP operates outside of the credit union’s normal trade area;
or,
0 The credit union does a majority of their business with one

dealership or one finance and insurance (F&I) person.
Regulatory Federal credit unions may participate in IDFPs under both the authority
Issues to make loans to members (see §107(5) of the FCUAct and 5701.21 of
Page 10A-43
EXAMINER'S GUIDE
the NCUA Rules and Regulations) and the authority to purchase

eligible obligations of members (see 5 107(13) of the FCU Act and
5701.23 of NCUA Rules and Regulations.) Participation under the loan
authority requires the following:
0 The federal credit union must make the final underwriting decision.
That is, before the dealer and member sign the sales contract, the
credit union must actually review the application and other
documents and determine that the transaction conforms to its
lending policies (federal credit unions may not delegate their
lending authority to a third party); and
0 The dealer must assign the sales contract to the federal credit union
very soon after the member and dealer sign it. An indirect loan is a
loan to a member (within the meaning of §107(5) of the FCUAct
and 570 1.2 1 of the NCUA Rules and Regulations) only if the
formation of a sales contract, the assignment of the loan to the
credit union, the transmittal of funds to the dealer, and the
establishment of a debtor-creditor relationship between the credit
union and the member occur in a very short time frame.
When dealers do not assign contracts within a short time frame or

when the credit union does not review the application and other
documents prior to agreeing to fund them, NCUA considers them to be
purchases of eligible obligations and, as such, limits them to five
percent of the credit union's unimpaired capital and surplus.
Direct versus Many credit unions, through arrangements with local retailers (auto
Indirect Point dealerships, appliances and electronic equipment stores, etc.), have
of Sale direct dealer financing programs (DDFP.) While the majority of the
Programs
items pertaining to IDFPs can apply to DDFPs, the major differences
between the two programs are as follows:
0 In most cases, DDFPs do not involve signing up new members

(i.e., borrowers must already belong to the credit union);
0 Credit unions write loans with the same rates and terms for all
members, leaving no room for the dealer to negotiate terms;
Page 1QA-44
Credit unions do not process non-member loans when dealers

mistakenly submit them;
0 Credit unions have the right of first refusal of their members’ loans
(i.e., the dealer does not shop the sales contract until the credit
union rejects the loan); and
0 Credit unions issue the “adverse action notice” if they do not grant
the loan.
Leasing Part 7 14 of the NCUA Rules and Regulations addresses permissible

leasing activities for credit unions. Credit unions may engage in:
0 Direct leasing, whereby the credit union purchases the property and
leases it back to the member;
Indirect leasing, whereby the member has a lease and the credit
union purchases the lease from a third party (subject to $714.3);
Open-end leasing, where the member assumes the risk for any
difference in the estimated residual value and actual value at lease
end; and
Closed-end leasing, where the credit union assumes the risk for any
difference in the estimated residual value and actual value at lease
end.
Part 714 further specifies:
0 Credit unions can only finance leases to their members;
Credit unions may only offer a net, full payout lease. In a net lease,
the member assumes all the burdens of ownership (maintenance,
repair, licensing, registration, taxes, and insurance.) In a full payout
lease, the credit union expects to recoup its entire investment in the
leased property (amount financed), plus the cost of financing;
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EXAMINER'S GUIDE
0 The amount of the estimated residual value cannot exceed 25

percent of the original cost of the leased property (unless the excess
is guaranteed);
Credit unions must retain salvage powers over the leased property.
The credit union must retain the power to take action to protect the
value of the property if there is a change in conditions that
threatens their financial position (such as failing to maintain
insurance); and
Credit unions must maintain a contingent liability insurance policy

with an endorsement for leasing (or be named a co-insurer for
indirect leasing) from an insurance company rated B+ or better.
Residual Value Most automobile lease arrangements use residual value insurance
Insurance coverage. Industry experts publish price guides showing residual
values (e.g., Automobile Leasing Guide or Black Book.) Residual
value insurance protects the credit union from errors in value
estimation.
The credit union must determine the financial strength and reputation
of the insurance company before purchasing residual value insurance
coverage. The insurance company will only pay a claim for losses due
to excessive devaluation of a vehicle at the end of the lease term. If, for
any reason, the lease terminates early, this insurance does not apply.
Auto Every member must carry normal liability and property insurance on
Insurance the leased property. The member must name the credit union as an
additional insured on the liability insurance policy and as the loss
payee on the property insurance policy.
Regulation Regulation M implements the consumer leasing portions of the Truth

"M" in Lending Act to assure member-lessees receive accurate disclosures
that allow members to compare various lease terms. The regulation
also places limits on the size of balloon payments and specifies some
advertising requirements. The credit union need not disclose "interest"
Page 10A-46
rates to the member, and usury laws do not apply. Lease contracts refer
to fees rather than interest.
The regulation applies to leases that have the following characteristics:
Term longer than four months;

Leased property valued at no more than $25,000;
Purchases personal property for personal, family, or household use;
and
Natural person lessee.
Following are the required disclosures for Regulation M:
Description of the leased property;

Amount due at lease signing;
Payment schedule and total amount of periodic payments;
Other charges (i.e., the amount of any liability the lease imposes
upon the lessee at the end of the lease term);
Total of payments;
Payment calculation:
- Gross capitalized cost;
- Capitalized cost reduction;
- Adjusted capitalized cost;
- Residual value;
- Depreciation and any amortized amounts;
- Rent charges;
- Total of base periodic payments;
- Lease term;
- Base periodic payment;
- Itemization of other charges; and
- Total periodic payment;
Early termination:
- Conditions and disclosure of charges; and
- Early-termination notice;
Maintenance responsibilities:
- Statement of responsibilities;
- Wear and use standard; and
- Notice of wear and use standard;
Purchase option:
- End of lease term; and
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EXAMINER'S GUIDE
- During lease term;

0 Statement referencing nonsegregated disclosures;
0 Liability between residual and realized values;
0 Right of appraisal;
0 Liability at end of lease term:
- Rent and other charges;,
- Excess liability; and
- Mutually agreeable final adjustment;
0 Fees and taxes;
0 Insurance:
- Through the lessor; or
- Through a third party;
0 Warranties or guarantees;
0 Penalties and other charges for delinquency;
0 Security interest; and
0 Limitations on rate information.
Failure to comply with the Consumer Leasing Act increases

compliance risk and may result in criminal and civil penalties. Lessors
must retain evidence (paper copies are not required) documenting their
compliance with the Consumer Leasing Act regarding actions they
performed and the required disclosures they made. The lessor must
retain, for at least two years, enough information to reconstruct the
required disclosures or other records. The Compliance chapter
discusses Regulation M in more detail.
Income on Lease contracts refer to income on leases as ''fee income" rather than
Leases "interest income". Therefore, lease contracts do not disclose an
"interest rate" to the member. The credit union must know the costs of
the lease and their overhead costs in order to determine the lease
program's profitability. A well-managed lease program should identify
the profit margin on leases.
Because a portion of each lease payment contains some principal

return to the credit union, the credit union should use an effective
interest method of recording income consistent with GAAP. This
"interest rate" must be consistent with the "fees" disclosed in the lease
agreement, but the credit union need not disclose the rate itself to the
member, although some credit unions voluntarily disclose this rate.
Page 10A-48
Leasing The credit union should implement internal controls to mitigate the
Program following problems posed by a leasing program:
Problems
0 The credit union bears responsibility for credit risk. Residual value
insurance does not benefit the credit union if a lease becomes
delinquent. The member does not own the vehicle, usually makes
no down payment on it, and therefore, does not have a vested
interest in the vehicle. If the member defaults on payments and if
the credit union repossesses the vehicle, the credit union would
have to dispose of it and bear the depreciation expense. Credit
unions must not view all of the insurance policies associated with
auto lease programs as a substitute for quality underwriting
procedures. Credit unions should take prompt action to limit losses
on leases.
Intense competition in the leasing area may tempt credit unions to

offer lower lease payments by increasing the residual values.
Manipulating and inflating residual values can result in significant
losses to the credit union.
0 Vehicles depreciate rapidly when they are new and gap insurance
may not cover losses due to theft of the vehicle. Members will not
continue paying on a wrecked or stolen vehicle, and the insurance
company probably will not give the credit union book value (per
the credit union's books) for the vehicle.
0 If the credit union is the owner of the vehicle, a contingent liability

may exist relative to the operation of the automobile.
0 Although the member must properly maintain the vehicle, the

incentive to maintain it lessens if the member intends to turn it in
at the conclusion of the contract term. Poor or no maintenance may
decrease the value of the vehicle at the conclusion of the lease. The
credit union can penalize the member for a breach of the contract
and impose a fee. However, the credit union may have difficulty
collecting those fees the member feels are unwarranted.
0 In closed-end leasing, losses resulting from depreciation and the

credit union's inability to sell the vehicle for the loan balance at the
end of the lease contract are the sole liability of the credit union,
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EXAMINER'S GUIDE
unless it obtains appropriate insurance coverage. Closed-end

leasing contains a level of risk that the credit union should
understand and carefully evaluate.
Using an outside party presents some risks. The benefits of using

the services of a CUSO or leasing company include minimizing the
credit union's administrative burdens and liability. However, if a
credit union invests in or lends to a CUSO, and the CUSO fails, it
can lose its investment in the CUSO, its loan to the CUSO, and the
services that the leasing company CUSO provide. Since the credit
union relies on the services of the CUSO, it should monitor the
CUSO's financial condition and operations. Further, if the CUSO
or leasing company files bankruptcy, the credit union may
encounter difficulty obtaining title to the vehicles if the titles are in
the name of the CUSO or leasing company at the time of
bankruptcy. A participating credit union must monitor the financial
condition of CUSOs or leasing companies.
The credit union should have on file an attorney's opinion

acknowledging that, in the event of bankruptcy, the leased vehicles
are the credit union's assets, not assets of the CUSO or leasing
company.
Additional burdens could fall on the credit union if, at the end of
the lease term, members return the vehicles to the credit union. The
credit union must have written agreements for vehicle disposition
at the time of lease termination to reduce the possibility of its
becoming a used auto sales company. It should enter into written
automobile disposal agreements with the residual value insurance
company or local used auto dealers or auctions to reduce the
potential of incurring a loss on the value of the vehicle. If a credit
union uses a CUSO for leasing, this normally becomes the CUSO's
responsibility.
0 The potential for fraud exists in any program. Credit unions should
check with their surety company and determine whether they need
special bond coverage for lease financing.
0 Interest rate risk exists with auto leasing as with any "loan"
portfolio. When analyzing the profitability of a leasing portfolio,
Page 10A-50
the credit union must consider several factors, including the cost of
CUSO service, the cost of insurance (usually included in the fee to
the CUSO), the cost of credit risk, and the opportunity cost of the
money invested.
0 The credit union must consider service to members. Longer-term

leases usually generate more profit to the credit union than short-
term leases. Short-term leases may generate less profit than
conventional loans. Some leases have marginal income spreads. If
so, examiners should ensure that the credit union understands this
condition and determine the profitability of the overall portfolio.
Balloon Balloon loans are loans with large final payments. The following
Notes inherent risks exist:
The credit union may not contact the borrower frequently enough
to learn of new financial problems of the borrower;
0 The contracted balloon payment may exceed the borrower's ability

to pay (borrower's expectations failed to materialize);
The borrower may be unable to make final payment or obtain

affordable financing elsewhere, when the contracted balloon
payment comes due. When collateral depreciates faster than the
loan balance amortizes, the collateral may no longer adequately
secure the loan; and,
0 The credit union may have liquidity problems due to a lack of cash
flow.
Balloon notes present significant problems to management in

establishing a sound asset-liability management (ALM) program. The
credit union's ALM policies must clearly address how the credit union
manages the risks inherent in balloon loans. Ideally, credit unions
should match balloon note assets with equal maturity liabilities.
Boat Loans Boats come in multiple shapes and sizes with costs ranging from less
than $500 to over $1 million. There are two recognized categories of
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EXAMINER'S GUIDE
boats based on displacement size, each with different requirements for

perfection of liens.
0 Boats with net displacement under five tons. This category

contains mostly mass-manufactured recreational boats. While
displacement differs for various hull types and shapes, generally
boats under 32 feet fall into this category. Credit unions can
determine the value of boats in this category from NADA (see
nada.com) and Blue Book publications; similar to the way they
determine the value of automobiles. Lenders can request
independent appraisals if they cannot determine the value of a
specific craft or its condition. In general, well-maintained boats
hold their values much longer than automobiles or other
recreational equipment.
Requirements for perfecting lien interests in small boats vary from

one state to another. Most states title boats the same way they title
automobiles. In some states, lien perfection requires filing a UCC-
1. The credit union should familiarize itself with the requirements
of the applicable states.
0 Boats with net displacements over five tons. The U.S. Coast Guard
regulates boats in this category, which generally operate in the
open ocean, Great Lakes, and other large bodies of water (often as
commercial fishing vessels.) Thus, loans for this type of boat may
require business loan documentation. Credit unions should use
caution when granting loans where the payments depend on
income from a commercial fishing venture, since the cash flow is
often seasonal (e.g., the limited Alaskan halibut season.) With the
limited number of prospective buyers, high deficiency balances can
result from defaults.
Many boats in this category have a mass manufactured hull, but the
remainder of the boat is often custom built for an individual buyer.
Equipment and quality of fit and finish vary widely. Before
extending credit on boats in this category, credit unions should
obtain a marine survey and an appraisal, especially important when
the credit union grants a loan on a used vessel. A marine survey is
a detailed report on the boat, its equipment, condition,
seaworthiness, and compliance with Coast Guard fire and safety
Page 10A-52
regulations. Appraisers often require the completed survey before

providing a firm value.
Perfection of a lien on a boat in this category requires a preferred

marine mortgage filed with the U.S. Coast Guard.
Page 10A-53
GLOSSARY OF LOAN TERMS APPENDIX IOB -
Glossary of Capitalized Cost: the amount financed or the final capitalized cost (cap cost) to the
lessee.
Auto Leasing
Terms Closed-End Lease: most consumer leases are closed-end leases. In a closed-end
lease, the credit union assumes responsibility for any deficit between the agreed upon
residual value and the vehicle's actual value at the end of the lease. This type of lease
is often referred to as a "walk-away" lease.
Direct Lease: a lease where the credit union becomes the owner of the property at
the request of the member and leases the property to the member.
Excess Mileage: the residual value is based on the leased vehicle having an exact
number of contracted miles over the term of the lease. This mileage criteria is a major
consideration in establishing the residual value. If the lessee anticipates additional
miles at the beginning of the lease, the residual value can be lowered to account for
the usage. If the mileage at lease end exceeds the amount contracted for, the excess
mileage is billed at a predetermined cost per mile.
GAP Insurance: at any time during a loan's life, a payoff can be requested to
determine the balance if paid in full before the scheduled end of the loan. This is
often referred to as the net payoff. When a vehicle is stolen or considered a total
collision loss, the insurance company negotiates a final settlement for the insured. In
many cases, the settlement amount is less than the net payoff leaving a deficiency for
which the borrower is still liable. GAP insurance pays the difference between the net
payoff and the insurance settlement less the insurance deductible, thus eliminating the
loss or deficiency.
Indirect Lease: a lease where the credit union purchases the lease and the leased
property (or is assigned the lease and has a lien on the leased property) after the lease
has been executed between a leasing company and the member.
IRPS 83-3: the NCUA's Interpretive Ruling and Policy Statement (IRPS) 83-3
authorizes federal credit unions to become involved in either direct or indirect, and in
either open-end or closed-end financing of leased property. The personal property
financed must secure the loan. All requirements and limitations established in the
Federal Credit Union Act, the NCUA Rules and Regulations (particularly Sections
70 1.21 and 70 1.23), Regulations B and M, and local state laws must be followed.
Lessee: the party who actually uses the vehicle. The credit union member is the
lessee.
Lessor: the party that enters into the lease with the credit union member. This may be
the credit union, leasing company, or CUSO.
Open-End Lease: in an open-end lease agreement, the credit union member would
take responsibility for any deficit between the agreed upon residual value of the
property and its actual value at the end of the lease. This type of lease would be rare
because the residual value would have to be less than 25 percent of the price of the
vehicle and the member would have to accept this depreciation risk. These factors
would make a lease agreement very unattractive to the member.
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EXAMINER’S GUIDE
Residual Value: the projected future value of the leased vehicle. The value will vary
based on the term of the lease, type of vehicle, and contracted mileage. Residual
value is usually expressed as a percentage of the vehicle’s MSRP (manufacturer’s
suggested retail price).
Glossary of Buy Down Rate: a lower rate than the dealer’s “buy rate.” The dealer will pay the
credit union the difference in the amount of the finance charges between the dealer’s
Indirect buy rate and buy down rate. This provides a lower rate to the dealer’s customer
Dealer (lower payments) allowing the dealer to complete the sale.
Finance Conditional Sales Contract: agreement between the dealer and purchaser describing
Paper (IDFP) the merchandise with add-ons, agreed upon price, etc.
Terms
Captive Financiers: General Motors Acceptance Corporation, Toyota Motor Credit,
Ford Motor Credit, etc.
Dealer’s Buy Rate: the loan rate charged the dealer by the credit union. The rate
offered to the dealer is usually between 0.25 and 1.OO percent less than the rate
offered to members (lobby rate).
Dealer’s Invoice: factory invoice describing the vehicle and the amount the dealer
paid for the vehicle.
Dealer’s Reserve: general ledger account balance owed to the dealer. It may
represent an amount that must be retained in the dealer’s reserve under the control of
the credit union to assist in rehnding interest on prepaid contracts, and to offset
losses on contracts for which the dealer is obligated but has not performed.
F&I: an automobile dealership’s Finance and Insurance Department.
Hold-Back Reserve: similar to dealer’s reserve account, but usually represents a

stipulated portion of the rate differential on a contract that the credit union believes
represents a greater risk than normally accepted from the dealer.
Holder-in-Due Course: a liability situation created for the lender when the lender
establishes a business relationship (e.g., IDFP) with the seller of a product (dealer).
This area should be addressed in the Dealership Agreement to limit the loss exposure
to the credit union.
Indirect Dealer Financing: financing arrangement whereby the dealer facilitates

loans made by the credit union to members. The credit union is responsible for
making the underwriting decision and the loan is assigned to the credit union
immediately after being made.
Lobby Rate: rate charged members for direct financing with the credit union.
Post Purchase Audit: a detailed review of the paper submitted by the dealer to
ensure the faxed application and sales contract agrees with the final paperwork
submitted by the dealer, and the merchandise, add-ons, and insurances are
appropriately priced. Usually performed for all new dealerships and periodically
through the business relationship.
Page 10B-2
GLOSSARY OF LOAN TERMS - APPENDIX 10B
Quality Rating System: any number of loan rating methods designed to determine
the risk assigned to a particular loan. (If the credit union is using some type of quality
rating system, the amount and maturity of the hold back reserve should be adjusted in
relation to the risk involved.)
Rate Differential: difference between the dealer’s buy rate and the rate charged the
customer. The higher the rate the customer will pay the more the dealer’s profit on the
financing.
Recourse Agreements: affects the lender’s ultimate collectibility should the loan
become delinquent. There are three types of recourse: 1) under “full recourse” the
dealer must purchase the loan at the credit union’s demand; 2) “limited recourse”
would require the dealer to buy back the loan or repossess the goods if the credit
union fulfills certain obligations; and 3) with “no recourse” (the most common), the
dealer has no obligation on the loan unless fraud or misrepresentation was involved.
Retail Verification: also referred to as “after-purchase survey,’’this process serves

as an internal control and quality control function (and, incidentally, presents an
opportunity for the credit union to cross sell other loans and services.) An individual,
other than the loan officer, calls the borrower after the loan is processed to ensure the
dealer did not misrepresent the deal to the credit union or the member (APR, trade-in,
out of pocket down-payment, accessories, insurance, etc.) This process should be
completed for all new dealerships and F&I persons for the first 25 deals and then
randomly thereafter (20 percent to eventually 10 percent of deals) as the relationship
matures. The credit union considers a newly hired F&I person a new relationship.
Glossary of ActuaVActual Remittance Type: a method of sending monthly mortgage payments

to the loan owner that requires the lender (servicer) to remit only the interest and
Real Estate principal payment it actually receives fiom mortgagors.
Lending
Adjustable-Rate Mortgage Loan (ARM): a mortgage that allows the lender to
Terms adjust the interest rate periodically based on the movement of a specified index.
ALTA - American Land Title Association: a national association of title insurance

companies, abstractors, and attorneys specializing in real property law. The
association establishes standard procedures and title policy forms.
Amenity: an aspect of a property that enhances its value, e.g., off-street parking,
availability of good public transportation, tennis courts, or a swimming pool.
Amortization: gradual reduction of the debt through periodic payments scheduled

over the mortgage (debt) term. A loan payment schedule characterized by equal
periodic payments calculated to meet current interest payments and retire the
principal at the end of a fixed period.
Appraisal: a written report by a qualified person that sets forth an estimate or

opinion of value. The term also refers to the process by which this estimate is
obtained.
Arms-Length Transaction: a transaction between a willing buyer and a willing

seller with no undue influence imposed on either party, and where there is no
relationship between the parties except that of the specific transaction.
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EXAMINER'S GUIDE
Assumption: a method of selling real estate wherein the property purchaser agrees to
take over the primary liability for payment of an existing mortgage.
Balloon Mortgage: a mortgage that has level monthly payments that would fully
amortize it over a stated term, but which provides for a balloon payment to be due at
the end of an earlier specified time, e.g., 30-year amortization, with balloon payment
due in five years.
Balloon Payment: the remaining balance of a mortgage that must be paid in a lump
sum at the end of the mortgage term. The amount represents more than a monthly
payment and is generally substantial, e.g., the balloon payment on a $50,000
mortgage with a five-year term and 30-year amortization at 8.75 percent is scheduled
to be $47,800.
Bankruptcy: a proceeding in a federal court in which debtors who owe more than
their assets can relieve the debts by transferring their assets to a trustee. This affects
the borrower's personal liability for a mortgage debt but not the lien of the mortgage.
Basis Point: 1/100 of one percent.
Biweekly Mortgage: a mortgage that requires payments to reduce the debt every two
weeks.
Blanket Lien: a lien on more than one parcel or unit of land, frequently incurred by
subdividers or developers who have purchased a single tract of land for the purpose
of dividing it into smaller parcels for sale or development.
Bridge Loan: a temporary loan generally made to borrowers who need financing
between the purchase of a new home and the sale of an old home. Also called a
"swing loan."
Cash-out Refinance: a refinance transaction in which the amount of money received

from the new loan exceeds the total of the money needed to repay the existing first
mortgage, closing costs, points, and the amount required to satisfy any outstanding
subordinate mortgage liens.
Closing: the completion of a real estate transaction that transfers rights of ownership
to the buyer. Also called "settlement."
Closing Costs: money paid by the borrower to enact the closing of a mortgage loan.
This normally includes an origination fee, title insurance, survey, attorney's fees, and
such prepaid items as taxes and insurance escrow payments.
Common Areas: those portions of a building, land and amenities owned by a

Planned Unit Development (PUD) or condominium project's owners' association (or
a cooperative project's cooperative corporation) that are used by all of the unit
owners. Common areas could include swimming pools, tennis courts, and other
recreational facilities, as well as common corridors of buildings, parking areas, etc.
Common Area Assessments: levies against individual unit owners in a

condominium or PUD project for additional capital to defray the owner's
association's costs and expenses to repair, replace, maintain, improve or operate the
common areas of the project.
Page 10B-4
Comparables: in appraising, properties of reasonably the same size and location

with similar amenities as the subject property. These are properties that have been
sold recently, thereby indicating the approximate fair market value of the subject
property.
Completion Bond: an insurance policy taken out for the lender that assures
completion of the construction project if the builder or contractor cannot complete it.
Condominium: a real estate project where each unit owner has title to a unit, an
undivided interest in the common areas of the project, and sometimes the exclusive
use of certain limited common areas. Fannie Mae does not purchase condominium
projects, but does purchase mortgages on individual units in the project.
Conforming Loan: a loan, the amount of which is less than or equal to the FNMA or
FHLMC maximum loan limit (with the exception of loans securing property in
Alaska or Hawaii which have higher limits).
Conventional Mortgage: a mortgage that is not insured or guaranteed by the federal

government.
Cooperative Mortgages: mortgages related to a cooperative project. They may be

multi-family mortgages covering the entire project or single-family mortgages
covering individual units (share loans).
Cooperative Project: a multi-family residential building that has multiple ownership

wherein a corporation holds title to the property and conveys units to individuals by
issuing shares of stock and occupancy agreements.
Cost Approach to Value: a method of measuring the value of a property based on

the cost of producing a substitute residence that has the same use and features as the
property being appraised.
Covenant: refers to the various conditions (both positive and negative) associated
with business loan and condominium promissory notes that the borrower or lender
must meet during the life of the contract.
Credit Report: a report from an independent agency that verifies (last

reportediknown)a loan applicant's current employment and income, and provides
information on previous debts and liabilities.
Credit Risk the risk that a borrower will default (often associated with mortgage
loans in view of their long-term nature.)
Credit Union Conforming Mortgage: a FNMA product that allows simplified

documentation (credit reporting, income and employment verification, and
application requirements) to facilitate FNMA's purchase of credit union-originated
loans.
Deed in Lieu: a deed given by a borrower to a lender to satisfy a debt and avoid
foreclosure.
Deed of Trust: in some states the document used in place of a mortgage; a type of
security instrument conveying title in trust to a third party covering a particular piece
of property; used to secure the payment of a note; a conveyance of the title land to a
Page 10B-5
EXAMINER'S GUIDE
trustee as collateral security for the payment of a debt with the condition that the
trustee shall re-convey the title upon the payment of the debt, and with power of the
trustee to sell the land and pay the debt in the event of a default on the part of the
debtor.
Default: the failure of a borrower to make a mortgage payment when due. A

delinquent loan is said to be in default.
Delinquency Advance: the deposit of a servicer's corporate hnds into its custodial
account to assure that the full monthly remittance due the secondary market will be
available on the remittance due date, even though the servicer has not collected the
actual funds from a delinquent borrower. A servicer may reimburse himself for
delinquency advances from subsequent collections.
Discount: the amount by which the face value of a mortgage exceeds its selling
price.
Discount Point: A percentage (usually one percent) of the loan amount (not the
purchase price) of the property. Discount points paid by the borrower or seller when
a loan is originated in order to increase the lender's actual yield.
Documentation: the use of FNMNFHLMC Uniform Instruments ensures that the

documentation associated with mortgage loans is complete and consistent with
secondary market standards.
Due-on-sale Provision: a covenant in a conventional mortgage that allows the lender

to call the mortgage due and payable if ownership of the mortgaged property is
transferred without their permission.
Endorsement: additional coverage added to title insurance.
Errors and Omissions Coverage: a type of indirect loss insurance used to cover
losses that occur because of error or neglect on the part of an employee to whom a
specific responsibility has been assigned.
Escrow Account: the account holding that portion of the mortgagor's monthly
payment, held by the lender, used for the payment of taxes, hazard insurance,
mortgage insurance, and any other specified items as they become due.
Federal National Mortgage Association (Fannie Mae or FNMA): a major

purchaser of mortgage loans on the secondary market. A privately owned corporation
created by Congress to support the mortgage industry. It purchases and sells
residential mortgages insured by FHA or guaranteed by VA as well as conventional
home mortgages.
Federal Housing Administration (FHA): part of HUD whose main activity is to

insure residential mortgage loans made by private lenders. It sets standards for
construction and underwriting, but does not lend money or plan construction directly.
Federal Home Loan Mortgage Corporation (Freddie Mac or FHLMC): a

private corporation authorized by Congress to provide secondary mortgage market
support for conventional mortgages.
Page 10B-6
Fee Simple: the basic form of ownership, which conveys the largest bundle of
ownership rights, including air rights above and mineral rights below the property.
Fee Simple Estate: an unconditional, unlimited estate of inheritance that represents

the greatest estate and most extensive interest in land that can be enjoyed. It is of
perpetual duration. In a condominium, the owner owns only hisher unit in fee simple
and is an owner in common with respect to the land and other common portions of
the property.
FHA Mortgage: a mortgage insured by the Federal Housing Administration;may be

referred to as a "government" mortgage.
First Mortgage: a real estate loan that is the first lien against a property. First refers
to the order in time that the lien is filed.
First Right of Refusal: lien that allows a prospective buyer the chance to buy the
property before it goes on the market.
Fixed-rate Mortgage: a mortgage that provides for only one interest rate for the
entire term of the mortgage. If the interest rate changes because of enforcement of the
due-on-sale provision, the mortgage is still considered a fixed-rate mortgage.
Foreclosure: the legal process by which a borrower in default under a mortgage is

deprived of his or her interest in the mortgaged property. This usually involves a
forced sale of the property at public auction with the proceeds of the sale applied to
the mortgage debt.
Ginnie Mae (GNMA), Government National Mortgage Association: a

government-owned corporation within the US Department of Housing and Urban
Development (HUD) that issues mortgage-backed securities in exchange for
FHANA mortgages.
Hazard Insurance: insurance coverage that compensates for physical damage to the
property (e.g., by fire, wind, or other natural disasters).
Home-Equity-Line-of-Credit (HELOC) Loan: a mortgage loan, usually in a junior

lien position, that allows the borrower to obtain multiple advances of the loan
proceeds at his or her discretion, up to a stated amount that represents a specified
percentage of the borrower's equity in a property.
Home Mortgage: a residential mortgage on a one-to-four-family property.
HUD, Department of Housing and Urban Development: department responsible

for the implementation and administration of government housing and urban
development programs, including community planning and development, housing
production and mortgage credit, and equal opportunity in housing.
Improvements: those additions to raw land that normally increase its value, e.g.,
buildings, streets, and sewers. Off-site improvements are improvements outside the
boundaries of a property, e.g., sidewalks, curbs and gutters. On-site improvements
include construction of buildings or other improvements within the property's
boundaries.
Page 10B-7
EXAMINER'S GUIDE
Income Approach-to-Value: a method of measuring the value of a property, which

is based on market rent or income that the property can be expected to earn.
Index Rate: a number that determines interest rate changes on adjustable-rate

mortgages, e.g., LIBOR, 11 COFI.
Installment Debt: borrowed money that is repaid in several successive payments,

usually at regular intervals, for a specific amount and term, e.g., automobile or
furniture loan.
Insured Closing: settlement performed at the title company, not the credit union.
Interest Rate Risk the risk that interest rates could increase or decrease
significantlyfrom the rates on loans held in a loan portfolio.
Junior Lien: any lien that is filed after the claims of the holder of a prior (senior)
lien.
Lease: a written agreement between the property owner and tenant that stipulates the
conditions under which the tenant may possess the real estate for a specified period
of time and rent.
Leasehold Estate: a way of holding title to a property wherein the mortgagor does
not actually own the property but rather has recorded a long-term lease on it.
Letter of Credit: a letter addressed by a financial institution, on behalf of a

borrower, to a third party, authorizing the third party to draw drafts up to a stipulated
amount under specified terms.
Lien: a legal hold or claim of one person on the property of another as security for a
debt or charge.
Liquidity Risk: the risk of having inadequate cash on hand to meet member needs. A
credit union in this position would be forced to borrow money or sell assets on what
may be unfavorable terms to raise cash.
Loan-to-Value (LTV) Ratio: the relationship between the unpaid principal balance
of the mortgage and the property's appraised value (or the sales price, whichever is
lower).
Market Conditions: lending in any area requires a thorough knowledge of the local
market, laws, customs and pricing.
Margin: a fixed-rate added to an index for determining the overall interest rate that
will be charged on adjustable-rate loans. The margin is usually stated in terms of
basis points, such as 100 BP, or as an interest rate, such as one percent.
Monthly Fixed Installment: that portion of the total monthly payment that is
applied toward principal and interest.
Mortgage: conveyance of an interest in real property given as security for the

payment of a debt. The deed by which such a transaction is effected. Collectively, the
security instrument, the note, the title evidence, and all other documents and papers
that evidence a lien on property as security for payment of a debt.
Page 10B-8
Mortgagee: a person or company to whom property is mortgaged.
Mortgagor (also Mortgager): a person who mortgages property (borrower,

homeowner).
Negative Amortization: a gradual increase in the mortgage debt that occurs when
the monthly installment is insufficient to cover interest. The interest shortage is added
to the unpaid principal balance to create negative amortization - an increase in the
principal amount owed.
Net Worth: the value of all assets, including cash, less total liabilities; often used to
indicate creditworthiness and financial strength.
No Cash-Out Refinance: a refinance transaction in which the mortgage amount is

limited to the sum of the unpaid principal balance of the existing first mortgage,
closing costs (including prepaid items), points, the amount required to satisfy any
liens that are more than one-year old (if the borrower chooses to satisfy them), and
cash to the borrower of up to one percent of the loan amount.
Non-assumption Agreement: a provision whereby if the loan is sold the buyer

cannot assume the debt.
Nonconforming Loan: a loan that FNMA or FHLMC will not buy because it
exceeds their maximum loan limits (with the exception of loans securing property in
Alaska or Hawaii which have higher limits.)
Nonstandard Loan: either a conforming or nonconforming loan supported by

nonstandard documentation, e.g., a TRW credit report rather than a Residential
Mortgage Credit Report.
Notice of Default: rider attached to title insurance for credit unions in a second lien
position. Requires the first lienholder to notify the second lienholder before
foreclosure.
Occupancy Status: Fannie Mae uses three definitions of ownership to determine

conventional mortgage eligibility:
0 Principal Residence - the borrower's primary residence. At least one borrower
must occupy and take title to the property and execute the note and mortgage.
0 Second Home - a single family property that the borrower occupies in addition to
the principal residence (a two- to four-family residence is not eligible for second
home status). When the property is classified as a second home, rental income
may not be used to qualify the borrower.
0 Investment Property - a property that the borrower does not occupy. This
definition is used whether or not the property produces revenue.
Origination Fees: the fees charged by a lender to prepare loan documents, make
credit checks, inspect, and sometimes to appraise a property. The fees usually are
computed as a percentage of the face value of the loan.
Operating Loan: a current liability. It funds the operations of the businesdfarm for
the cycle or period is due and payable within the operating cycle. Generally, used for
the acquisition and financing of inputs for the production cycle.
Page 10B-9
EXAMINER’S GUIDE
P & I (Principal and Interest): that portion of a homebuyer’smonthly payments to

the lender that composes the debt service on the mortgage.
Power of Attorney: transfer right (interest) in property to another person to act in

owner’s behalf.
Private Mortgage Insurance (PMI): insurance written by a private company,

protecting the lender against loss resulting from a mortgage default.
Promissory Note: borrower’s promise to repay a loan; used in all types of

borrowing. Contains the terms and conditions of the loan, including covenants
necessary in commercial lending. All promissory notes contain the amount borrowed
and the agreed upon interest rate - either fixed or variable.
Planned Unit Development (PUD): a real estate project in which each unit owner
has title to a residential lot and building and a nonexclusive easement on the common
areas of the project. The owner may have an exclusive easement over some parts of
the common areas (e.g., a parking space). Fannie Mae does not purchase PUD
projects but does purchase individual units in such projects.
Purchase-Money Transaction: the borrower obtains the mortgage to purchase the

property.
Quality Control: development of regular loan monitoring that addresses the credit,
collateral, and interest rate risk within a real estate loan portfolio. A system of
safeguards and checkpoints to ensure that all loans are originated, processed,
underwritten, closed, and serviced according to the lender‘s andor secondary
market’s requirements.
Quit Claim Deed: transfers a portion or all interest to another.
Reconveyance: to transfer lien back to previous position or owner
Recourse: a financial institution’sacceptance, assumption, or retention of some or all

risk of loss generally associated with ownership of an asset, whether or not the
institution owns or has ever owned the asset.
Red Lining: making home mortgage loans only in specified areas of towns or
municipalities.
Refinance Transaction: the repayment of a debt from the proceeds of a new loan
using the same property as security. Fannie Mae also considers the current owner’s
placement of financing on a property not financed as a refinance transaction.
RMCR, Residential Mortgage Credit Report: a detailed account of the credit,

employment, and residential history (as well as public records information) of a
borrower.
Sales Comparison Approach-to-Value: a method of measuring the value of a

property based on an analysis of comparable sales, contract offerings, and listings of
properties that are the most comparable to the property being appraised. (Also called
“market data approach”.)
Page 10B-10
Scheduled/Actual Remittance Type: a method of sending monthly mortgage

payments which requires the lender to remit the scheduled interest due (whether or
not it is collected from mortgagors) and the actual principal payments that it collects
from mortgagors.
Scheduled/Scheduled Remittance Type: a method of sending monthly mortgage

payments that requires the lender to remit the scheduled interest due and the
scheduled principal due (whether or not payments are collected from mortgagors.)
Second Mortgage: a mortgage that has a lien position subordinate to the first
mortgage because it was recorded later.
Secondary Market Lending Standards: participation in the secondary market

requires strict adherence to established industry mortgage lending standards.
Secondary Mortgage Market: the market in which existing mortgages and

mortgage-backed securities are bought and sold.
Servicing: the tasks performed to protect the mortgage investment including

collecting the monthly payments, managing the escrow accounts, monitoring and
dealing with delinquencies, and overseeing foreclosures and payoffs.
Servicing Compensation: the income that a servicer receives for the collection of
payments and management of operational procedures related to a mortgage, e.g., base
servicing fee, plus late fees charged for special services, yield differential
adjustments or excess yield, and, sometimes, a share in prepayment charges.
Servicing Released: sale of a mortgage loan along with the rights to service that loan
when the loan is sold in the secondary market.
Servicing Retained: retention of the rights to service a loan when the loan is sold in
the secondary market.
Subordinate Financing: any mortgage or other lien that has priority lower than that
of the first mortgage.
Subservicer: party under contract to the original lender to perform the on-going
servicing activities for the mortgage or pool. A qualified party acceptable to the
purchaser must service loans sold on the secondary market.
Subsewicing Arrangement: an arrangement wherein the contractually responsible

servicer of a mortgage or pool of mortgages hires another servicer to perform its
servicing functions.
T & I (Taxes and Insurance): that portion of a home buyer's monthly payments to
the lender transferred into an escrow fund to pay property taxes, the homeowner's
insurance premiums, and mortgage insurance, if applicable.
Title Insurance: insures against defects in title that were not listed in the title report
or abstract.
Trade Area: the area, as defined by the credit union's policies, where a stated type of
loan will be considered. The area must be such that the credit union will be able to
perform adequate monitoring of market conditions and of loans granted.
Page 10B-11
EXAMINER'S GUIDE
UCC, (Uniform Commercial Code): a comprehensive codification and

modernization of commercial law (excluding law dealing with real property). Each
state has adopted its own provisions to this codification.
VA Mortgage: a mortgage that is guaranteed by the Department of Veterans Affairs;

may be referred to as "government" mortgage.
Warranty Deed: contains a covenant of warranty whereby the coventor will defend
against the claims of all persons.
Wraparound Mortgage: a mortgage that includes the remaining balance on an

existing first mortgage plus an additional amount requested by the mortgagor. Full
payment of both mortgages is made to the wraparound mortgagee, who then forwards
the payments on the first mortgage to the first mortgagee.
Glossary of Deferment: time interval of postponement of principal payments on a Stafford Loan

during which the federal government makes the interest payments (excluding
Student Loan unsubsidized). Lendedservicer determines the deferments, which are authorized for
Terms borrowers who meet the following criteria:
0 Study at least half-time at an eligible school;
0 Study in an eligible graduate fellowship program;
0 Are seeking but are unable to find full-time employment;
0 Will suffer economic hardship from repayment (as determined by the lender
using Department of Education regulations);
0 Serve in an eligible internship program
Federal Family Education Loan Program (FFELP): formerly called the

Guaranteed Student Loan (GSL) program. Loans granted under this program are
insured. Qualified students and parents can borrow money for education. This
program includes Federal Stafford Loans (subsidized and unsubsidized), Federal
Parent Loans for Students (PLUS), and Federal Consolidation loans.
Federal PLUS Loans: unsubsidized loans to parents who are assisting their
dependent student. The parent is responsible for the loan repayment. Interest accrues
from the date of origination and is the responsibility of the parent borrower. The
loans have no grace period and repayment begins while the student is still in school.
Grace Period: the period of time between when a student ceases to attend school at
least halftime and when the loan repayment must begin (usually 6 months).
Guarantee Agencies: agencies designated by the US Department of Education to

guarantee loans made under the FFELP. The guarantee agency will reimburse the
lender for an eligible loan in case of default, borrower's death, bankruptcy, or total
and permanent disability. Each state has its own guarantee agency.
Insurance Premium: a fee, usually a percentage of the loan amount (up to 3

percent), deducted from the loan proceeds by the lender and transferred to the
guarantor agency. The guarantee agency establishes the premium amount.
Interest Benefits: payments made by the Department of Education to lenders. The

lender receives the full amount of the actual interest as long as the borrower remains
eligible.
Page 10B-12
MEMBER BUSINESS LOAN FINANCIAL RATIOS -
APPENDIX IOC
Member Credit unions should establish specific ratios to analyze their member business loans.
The following are intended to aid examiners in understanding the information
Business presented during the loan review.
Loan Ratios
0 Acid Test Ratio (or Quick Assets):
Cash + Cash Eauivalents + Accounts Receivable
Current Liabilities
Tests the company's short-term debt paying abilities. Only the current
assets that are readily converted into cash are used. Highlights
potential liquidity problems attributable to an inadequate mix of
current assets.
0 Current Ratio:
Current Assets
Current Liabilities
Most common indicator of a firm's short-run liquidity. Shows the

relationship between current resources and short-term debt. Puts the
dollar amount of the Working Capital calculation into ratio format for
comparison purposes.
Days Sales in Accounts Receivable (Collection Period):

Accounts Receivable (Year-End)
(Credit Sales / 360)
Earnings Per Share:

Net Income
Average Common Stock Outstanding
Shows the amount of earnings attributable to each share of common

stock held by the stockholders (owners).
0 Earnings Yield:
Earnings Per Share
Market Price
0 Gross Margin Ratio:

Gross Profit
Sales
Page 1OC-1
EXAMINER'S GUIDE
Interest Burden:
Interest Expense
Total Assets
Inventory Turnover:
Cost of Goods Sold
Average Inventory
Indicates the number of times the firm's inventory is turned over or

sold during a period. Generally, the higher the inventory turnover, the
more effective the firm is in its operations, the lesser the amount that
must be tied up in inventories, and the shorter the operating cycle
necessary to replenish cash. Too high a ratio may indicate lost sales as
a result of insufficient inventory on hand.
Long-Term Debt to Equity Capital:

Long-Term Liabilities
Equity Capital
Net Income to Sales, or Profit Margin:

Net Income
Sales
The relationship of net income to sales can evaluate the company's

efficiency in controlling costs and expenses in relation to sales. Does
not, however, consider the owner's investment necessary to generate
the sales and income. A return on investment ratio will overcome this.
Operating Margin:
Operating Income - Depreciation
Sales
Operating Profits to Sales:

Operating Profit
Sales
Pretax Income to Sales:

Pretax Income
Sales
Page 1OC-2
MEMBER BUSINESS LOAN FINANCIAL RATIOS - APPENDIX 1OC
0 Receivables Turnover:
Net Credit Sales
Average Net Receivables
Indicates how many times receivables are turned over or collected ch

period. Shows the efficiency with which the firm collects its
receivables and converts them to cash.
Generally, the higher the turnover, the better, as the firm will have
fewer resources tied up in receivables, collects at a faster pace, and
usually will have fewer uncollectible accounts. Receivable turnover is
often divided into the number of days in the business year to show the
average collection period in days. Comparing the company's average
collection period to the days in its typical credit terms gives an
indication of how aggressively the company's credit department
collects overdue accounts.
0 Return on Equity Capital or Return on Stockholders' Equity:

Net Income
Average Equity Capital
Reflects the residual return on the owners' equity.
0 Return on Total Assets:

Net Income + Interest Expense Wet of Tax)
Average Total Assets
The amount of net income earned in relation to total assets; an

indicator of a firm's efficiency in the use of its economic resources.
The ratio can be mildly distorted depending on the age of the company
and its assets. Average assets (beginning period assets plus ending
period assets divided by 2) are used as net income is earned over the
time period.
0 Sales to Cash:
Sales
Cash
0 Sales to Accounts Receivable:

&&
Average Accounts Receivable
Accounts receivable turnover ratio.
Page 1OC-3
EXAMINER'S GUIDE
0 Sales to Inventory:
Sales
Inventory
0 Sales to Working Capital:

Sales
Working Capital
0 Sales to Fixed Assets:

Sales
Fixed Assets
0 Sales to Total Assets:

Sales
Total Assets
The ability of the company to minimize the level of assets (current and
fixed) to support its level of sales.
0 Times Interest Earned:

Operating Income Before Interest and Taxes
Interest Expense
An indicator of the firm's ability to cover its interest obligation through

its annual earnings. It is a measure of the safety of the creditors'
(particularly long-term) investments in the firm.
0 Total Debt to Total Capital (Debt Ratio):

Current Liabilities and Long-Term Liabilities
Equity Capital and Total Liabilities
or
Total Liabilities
Total Assets
Indicates the percentage of total assets contributed by creditors.

Subtracting the ratio from 100 is the percentage of total assets (or
equity ratio) contributed by stockholders (owners).
0 Working Capital Calculation:

Current Assets - Current Liabilities
Page 1OC-4
MEMBER BUSINESS LOAN FINANCIAL RATIOS - APPENDIX 1OC
Shows the dollar amount by which current assets exceed current

liabilities. Changes in the amount from one period to another is a
useful indicator of the businesses' short-term debt-paying ability.
Simplified Net Income xx

Add: Depreciation xx
Cash Flow Increase (decrease) deferred tax xx
Analysis Increase (decrease) working capital (see below) xx
Cash from operations
Increase (decrease) from investing activities xx

(i.e., fixed asset purchase)
Increase (decrease) from financing activities xx

(i.e., notes payable, long-term debt)
Net Increase (decrease) to cash xx

* * * * * * * * * * * * * *
Increase (Decrease) to Working Capital
Add:
Increase (decrease) to receivables
Increase (decrease) to inventory
(Increase) decrease to accounts payable
(Increase) decrease to interest payable
Page 1OC-5
SAMPLE IDFP AGREEMENTS = APPENDIX IOD
Sample This sample agreement is intendedfor use as a training aid for NCUA examiners
and should not be considered an all inclusive legal document to be shared with,
Dealer copied, or used by any other person or entity in whole or in part.
Purchase
The XYZ Federal Credit Union (“Credit Union”) agrees to purchase and the
Agreement undersigned Dealer (“Dealer”) agrees to sell, from time to time, loans entered into by
Dealer and Dealer’s customers (“Buyer”), pursuant to the terms of this agreement.
1. All loans offered by Dealer to Credit Union for purchase shall be secured by a
first lien on the vehicles sold by Dealer to Buyer (hereafter the “Collateral”).
2. All loans offered by Dealer to Credit Union for purchase shall be documented by
standard form installment agreement, together with documentation necessary to
perfect a first lien in the Collateral to secure the indebtedness (said documentation
collectively to be known as “Dealer Paper”).
3. Dealer may provide Credit Union with a copy of Buyer’s loan application via
facsimile transmission and obtain an approval of the loan and the terms that are
acceptable to Credit Union, or a disapproval of the loan. In the event Dealer tenders
Dealer Paper relating to a pre-approved application, Credit Union shall use all efforts
to promptly review said Dealer Paper and verify it complies with the terms and
conditions of the pre-approved application, before purchasing said Dealer Paper.
Credit Union is under no obligation to purchase any Dealer Paper which does not
comply with the terms of this Agreement as well as the terms provided by Credit
Union when pre-approving a loan.
4. All Dealer Paper tendered by Dealer to Credit Union shall be completed by

Dealer in a form acceptable to Credit Union and shall include, but not be limited to:
a. Original Loan Application;

b. Original Sales Contract;
c. ‘ Original Dealer’s Invoice;
d. Note and Disclosure;
e. Title Work;
f. Insurance Verification; and
g- Income Verification.
5. Dealer shall assign to Credit Union all Dealer Paper purchased by the Credit
Union and shall notify the appropriate authorities (including, but not limited to, the
Department of Transportation) of the assignment of the lien securing the
indebtedness to the Credit Union.
6. Credit Union has the option but not the obligation of purchasing any loan
tendered by Dealer, except Credit Union shall purchase any loan from Dealer that
complies with the terms of a pre-approved application.
Page 10D-1
EXAMINER’S GUIDE
7. For each loan purchased from Dealer, Credit Union shall promptly pay Dealer
(after receiving all required documentation) the amount of the loan (which may
include the cost of life and/or disability insurance and/or extended warranties sold to
Buyer), together with an incentive fee as set forth on a schedule provided to Dealer
by Credit Union from time to time.
8. As to all loans purchased by Credit Union, Dealer warrants:
(a) Dealer is authorized to sell said Dealer Paper; and
(b) The Dealer Paper is genuine and legally enforceable according to its terms;
and
(c) No buyer was a minor or incompetent when the Dealer Paper was executed;
and
(d) All statements contained in the Dealer Paper are true; Dealer has no notice
of any matters not disclosed to Credit Union which might impair the credit of buyers;
the disclosed cash down payment and trade-in were actually received by Dealer;
Dealer has not made and will not make any advance to Buyer; and Dealer has no
agreement with Buyer to separately finance or impose finance charges on Buyer or
defer payment of a portion of the down payment; and
(e) Within ten (10) days of delivery of the vehicle sold to Buyer, Dealer
perfected or will perfect a first security interest in the vehicle, time being of the
essence; and
( f ) The Dealer Paper and the transactions out of which it arose comply with all
applicable laws and regulation; and
(g) Dealer has performed or will perform all of its obligations to Buyer, and no
Buyer has asserted any defense, set-off, or counterclaim to Buyer’s liability under the
Dealer Paper; and
(h) At the time of sale, Dealer had authority to sell the goods to Buyer free of
any security interest or other encumbrance and the goods have been delivered to and
accepted by the Buyer within ten (1 0) days of the date of the Dealer Paper.
9. Dealer shall provide Credit Union with at least one bank reference and
authorizes Credit Union to investigate Dealer’s financial position from time to time
as determined in Credit Union’s sole discretion. Upon request, Dealer agrees to
provide Credit Union with sworn current financial statements.
10. Dealer agrees, with respect to any Dealer Paper sold to Credit Union, that:
(a) If Dealer places insurance on the Collateral or obtains credit life or credit
disability insurance for the Buyer, Dealer shall promptly pay to Buyer any premium
refunds or other amounts it receives regarding such insurance to which the Buyer is
entitled; and
(b) Dealer shall indemnify, defend, and hold Credit Union harmless from any
loss, liability, penalty, claim, damage, or expense claimed or incurred due to any act
or omission or commission of Dealer with respect to the Dealer Paper or the
Collateral (including, but not limited to, violation of any applicable Federal or State
Page 10D-2
SAMPLE IDFP AGREEMENTS - APPENDIX 10D
law or the breach of any of the provisions of this Agreement) which indemnification
shall include any costs and attorneys’ fees of credit union.
11. Credit Union may, without notice and without impairing Credit Union’s rights
against Dealer, in the name of Dealer or otherwise, take all actions and legal
proceedings deemed advisable by Credit Union with respect to the Dealer Paper or
the Collateral including, without limitation, modifying, extending, or compromising
any terms, discharging or releasing any person liable, or releasing any security;
Credit Union has no duty to perfect any security interest in the Collateral, to enforce
any rights of Dealer, or to preserve rights under this agreement against prior parties.
12. If any warranties or covenants of Dealer shall be false or breached with respect
to certain Dealer Paper, Dealer shall, upon request, repurchase the Dealer Paper from
Credit Union for the full amount unpaid thereon (less credit union’s unearned
interest) plus expenses incurred by Credit Union in endeavoring to collect or enforce
the Dealer Paper. Upon repurchase of the Dealer Paper, Credit Union will assign it to
Dealer without any recourse or warranties whatever.
13. Dealer covenants that it has performed and will continue to perform in a timely
manner all of its obligations to the Buyer, including its obligations which arise by
virtue of the contract and all agreements between the Buyer and Dealer and all
obligations which may arise by operation of law or otherwise. Dealer will advise
Credit Union in writing within ten (10) days if the Buyer notifies Dealer that Buyer
intends to assert any claim or defense against the Credit Union which arises out of the
relationship between Buyer and Dealer. In such case, Dealer shall within thirty (30)
days of receiving notice from the Buyer use its best efforts to resolve the claim to the
mutual satisfaction of the Credit Union and Dealer. If the Credit Union receives
notice from the Buyer of a claim or defense to be asserted against it, the Dealer shall
within thirty (30) days of receiving written notice of the claim from the Credit Union
use its best efforts to resolve the claim to the mutual satisfaction of the Credit Union
and Dealer. In the event Dealer cannot satisfactorily resolve the issue within the 30-
day period, Credit Union may demand Dealer to repurchase the Dealer Paper for said
loan, which Dealer shall purchase. The purchase price shall be the amount of
principal remaining due on said loan, together with any unpaid accrued interest due
as of the date of the sale by Credit Union to Dealer. Said sale shall be without
recourse to Credit Union.
14. This agreement is to be interpreted under the laws of the State of
15. Upon execution, this Agreement shall bind the parties and their successors and
assigns. This Agreement shall continue to be in effect for one year unless terminated
by either party upon at least 60 days prior written notice. Unless so terminated, this
Agreement shall automatically renew itself on its anniversary date. Any termination
of this Agreement shall not affect the rights and duties of the parties regarding any
Dealer Paper sold to Credit Union by Dealer prior to the effective date of the
termination of this Agreement.
Dated this day of 9 19
DEALER: XYZ FEDERAL CREDIT UNION:
By: By:
Page 10D-3
EXAMINER’S GUIDE
Sample This sample agreement is intendedfor use as a training aid for NCUA examiners
and should not be considered an all inclusive legal document to be shared with,
Dealer copied, or used by any otherperson or entity in whole or in part.
Reserve
AGREEMENT between ABC Credit Union (credit union) and XYZ Rolls Royce Inc.
Agreement (Dealer).
FOR CONSIDERATION, and intending to be legally bound, the Credit Union and
Dealer Agree:
1. Definitions.
(a) “Amount Financed” means the amount financed as stated in a Contract.
(b) “Buy Rate” means the minimum annual interest rate which the Credit Union
is willing to accept from time to time, as determined by the Credit Union in its sole
discretion. The Credit Union shall quote its current Buy Rate to Dealer at any time
upon request.
(c) “Buyer” means a person who purchases a product from Dealer.
(d) “Collateral” means a product sold by Dealer to a Buyer under a Contract.
(e) “Contract” means an installment sale and security agreement evidencing the
sale of Collateral from Dealer to Buyer.
(0 “Contract Interest Rate” means the interest rate specified to apply under a
Contract before default. The Contract Interest Rate shall not exceed maximum rates
quoted by the Credit Union to Dealer from time to time. In no event shall the
Contract Interest Rate exceed the rate allowed by applicable law.
(g) “Paper” means one or more of Dealer’s Contracts.
(h) “Reserve” for each Contract means the excess of (i) the total interest
payable in accordance with the terms of the Contract calculated at the Contract
Interest Rate, over (ii) the total interest payable in accordance with the terms of the
Contract calculated at the Buy Rate in effect at the time the Credit Union purchases
the Contract.
2. Purchase. Dealer will from time to time offer to sell Paper to the Credit Union
under the terms of this Agreement. The Credit Union may refuse to purchase any
Paper offered by Dealer.
3. Purchase Price. The purchase price for a Contract shall be the Amount Financed
stated in the Contract plus the Reserve for the Contract. If Contract is prepaid before
scheduled full term, the Credit Union shall have the right to keep or be compensated
for part of the Reserve, as provided in paragraph 5 .
4. Reserve. At the time of each purchase of a Contract, the Credit Union shall
compute the Reserve for the Contract and deposit the amount of the Reserve, together
with the Amount Financed, into the Dealer’s share draft account. Dealer agrees to
make an initial minimum deposit into an interest bearing share savings account.
Dealer may withdraw from the share savings account from time to time, but not
below a minimum balance determined by the Credit Union taking into account the
volume of the Credit Union’s purchases of Paper from Dealer and the Credit Union’s
experience with that Paper. The initial minimum balance required is $500. Dealer
grants the Credit Union a security interest and lien in any credit balance in that
Page 10D-4
SAMPLE IDFP AGREEMENTS - APPENDIX 10D
account or in any other money or subsequently owed Dealer by the Credit Union. In
addition to all other remedies, the Credit Union may at any time, without notice or
demand, set off against any such credit balance or other money owed the Credit
Union by Dealer. Upon full payment or other liquidation of all Paper purchased by
the Credit Union from Dealer, and Dealer’s full payment of all amounts owed the
Credit Union, the Credit Union shall pay the balance of the account to Dealer.
5. The Credit Union’s Right to Reserve. If a Buyer prepays a Contract, if Buyer

defaults and collateral is repossessed, or if Dealer repurchases a Contract, Dealer
shall pay Credit Union a fractional portion of the Reserve for the Contract. The
numerator of the fraction shall be the excess of the scheduled term of the Contract in
months over the time in months the Contract was held by the Credit Union. (In the
case of repossession, the numerator shall be equal to the number of unpaid full
monthly payments remaining to fulfill the contract’s original term.) The denominator
shall be the scheduled term of the Contract in months. In determining months for this
purpose, partial months of 14 days or less shall be ignored, and partial months of 15
days or more shall be counted as one full month. For example, two months and ten
days shall be counted as two months; and two months and fifteen days shall be
counted as three months.
6. Term: Additional Terms. Upon the Credit Union’s acceptance, this document
shall constitute an agreement between parties which shall inure to and bind the
parties, successors and assigns. It shall continue in effect until terminated by either
party upon at least 60 days prior written notice to the other. In addition, the Credit
Union may terminate this agreement immediately upon notice to Dealer if Dealer
defaults or becomes the subject of bankruptcy or other insolvency proceedings.
Termination shall not effect the respective rights and obligations of the parties as to
Paper purchased prior to the effective date of termination. Waiver of any default shall
not constitute a waiver of any other default. This agreement shall be construed
according to the laws of the State of
7. Notice. Any notices given in connection with this agreement shall be in writing
and shall be either personally delivered or mailed in the first class United States mail,
postage prepaid, addressed to the last known address of the recipient. Notice by mail
shall be effective one day after such mailing.
Page 10D-5
EXAMINER'S GUIDE
DEALER
BY:
(Authorized Signature and Title)
(Type of Organization, Corporation, Partnership or Proprietorship)
(Street Address)
(City, State, Zip Code)
Dealer's personnel authorized to sign Contracts and drafts in connection with this
agreement are:
(Name and Title) (Sample Signature)
Accepted 3 19-
ABC Credit Union

BY
(Authorized Signature)
Page 10D-6
REAL ESTATE DOCUMENTATION CHECKLIST -
APPENDIX IOE
Real Estate 0 Loan Application
Loans - 0 Contract of Sale
General 0 Verification of Employment
0 Verification of Deposits
0 Residential Mortgage Credit Report
0 Uniform Residential Appraisals Report
- Property Survey
- Zoning Requirements
Flood Insurance StatementICoverage
Debt Ratio Computation Page
Title Insurance
Title BindedTitle Policy
FNMAEHLMC Mortgage or Deed of Trust
FNMNFHLMC Note
FNMARHLMC Deed
Private Mortgage Insurance, if applicable
RESPA Settlement Statement
Current Hazard Insurance
Notice of Recision, if nonpurchase mortgage on residence
Termite Inspection, if applicable
General Home Inspection, if applicable
Radon Inspection, if applicable
Adjustable RateNariable Rate Rider
Loan to Value Ratio Computation
Verification of the Balance of the First Trust Deed
Other Documents, as necessary
Real Estate Add to General list:

with Mobile Deed to Real Estate with Title to Mobile Home
Home Documentation Whether Wheels Have Been Removed
Purchase Order or NADA Value
Sewage Permits or System, as needed
Water Availability
UCC Lien for Tongue and Wheels
Page 10E-1
EXAMINER'S GUIDE
Construction Add to General list:

Loans 0 Title Insurance Binder, with
- Periodic Insurance
- AdjustmentslNotifications
0 Take-Out Commitment
0 Construction Loan Agreement
0 Identification of Contractor
0 Borrower's Risk Insurance on Builder
0 Architect's Plans
0 Builder's Cost Estimates and Line Item Budget
0 Completion Bond, if required
0 Periodic Inspection Reports Based on Phase Completions
0 Photos of Inspection Phases and the Completed Project
0 Schedule of Disbursements
0 Building Permits
0 Environmental Considerations
0 Sewage Permits or System, as needed
0 Feasibility Study
0 Change Order Documentation
Unimproved Agreement that Improvements Cannot be Made to the Property without Credit
Property Union Consent
Page 10E-2
Chapter 11
ALLOWANCE FOR LOAN AND LEASE LOSSES
TABLE OF CONTENTS
ALLOWANCE FOR LOAN AND LEASE LOSSES ..................................................... 11-1

Associated Risks .................................................................................................. 11.1
Overview.............................................................................................................. 1 1.1
..
Definitions............................................................................................................ 11-2
Documenting the ALLL ....................................................................................... 11-2
Analysis of ALLL ................................................................................................ 1 1-3
Application of GAAP .............................................................................. 11-3
Policies and Procedures ........................................................................... 1 1-4
Methodology ............................................................................................ 11-5
Documenting ALLL Methodology .......................................................... 11-7
Allowance for Individual Impairment of Large Balance. Non-
Homogenous Loans (FAS 114)................................................................ 11-9
Allowance for Small Balance Homogenous Pools of Loans
(FAS 5 )..................................................................................................... 11-10
Estimating Loss on Pools of Loans .......................................................... 11.11
Summarizing Components and Consolidating the Amount of the ALLL ...........11.14
Validating ALLL Methodology ........................................................................... 11.14
Supporting Documentation for the Validation Process............................ 11.15
When a Document of Resolution is Required ...................................................... 11.16
Workpapers and References................................................................................. 11.16
APPENDIX 11A .ALLL FACTS, QUESTIONS, and ANSWERS ............................... 11A- 1
Chapter 1I

Examination Determine if management has a sound methodology, with
0bjectives supporting documentation, for estimating the amount of probable
existing losses in its loan and lease portfolio
0 Assess the overall adequacy of the Allowance for Loan and Lease
Losses (ALLL)
0 Ensure management understands the purpose of the ALLL
Associated Compliance risk - Includes the risk that the credit union does not
Risks present ALLL in compliance with the laws and regulations.
Transaction risk - Includes the risk that internal controls do not
sufficiently deter or detect errors, omissions or material
misstatements.
0 Reputation risk - Includes the risk that management did not meet
its fiduciary duty to properly reserve for probable existing losses,
resulting in poor publicity or administrative action.
Overview The boards of directors of federally-insured credit unions bear

responsibility for ensuring their credit unions have controls in place to
consistently maintain the ALLL in accordance with the credit union’s
stated policies and procedures, generally accepted accounting
principles (GAAP), and ALLL supervisory guidance. They should
instruct management to develop and maintain appropriate, systematic,
and consistently applied procedures to determine the amounts of the
ALLL and provisions for loan losses.
The ALLL provides an estimate of probable but unconfirmed losses in

the loan portfolio as of the financial statement date; it is not a reserve
for future anticipated losses. GAAP has as a primary objective for the
ALLL to ensure a credit union recognizes and measures loan
impairment in the period the impairment occurs and in the amount of
that impairment. This applies to all credit unions, regardless of size.
Page 11-1
EXAMINER’S GUIDE
If the credit union obtains a certified public accountant (CPA) opinion

audit, examiners can place reliance on the CPA’s review of the ALLL.
The Supervisory Committee chapter contains additional guidance.
Definitions Following are definitions used in this chapter:
0 ALLL: A contra asset account established and maintained by periodic charges to

operating expense to provide a credit union’s best estimate of the probable
amount of loans it will be unable to collect based on current information and
events and the amount of the loss can be reasonably estimated.
0 Homogenous: Of the same kind or nature; having similar parts or elements.
0 Impairment of loans: A loan is impaired when it is probable that a creditor

(credit union) will be unable to collect all amounts due, including principal and
interest, according to the contractual terms and schedules of the loan agreement.
Layering: The inappropriate practice of recording in the ALLL more than one
amount for the same probable loan loss. Layering can happen when a credit
union includes a loan in one segment, determines its best estimate of loss for that
loan either individually or on a group basis (after taking into account all
appropriate environmental factors, conditions, and events), and then includes the
loan in another group, which receives an additional ALLL amount.
Loan Segmentation: Presentation of information about certain parts of a loan

portfolio, in contrast to information about the entire loan portfolio.
0 Migration Analysis: A method to determine the adequacy of valuation

allowances by tracking movements (or migration) of a classified asset to a worse
classification in order to estimate a loss percentage likely to be incurred from
different categories of assets within the current portfolio.
Probable: Higher level of likelihood than “more likely than not.”
Non-homogenous: Not of the same kind or nature.
Documenting The examiner should ensure the credit union has appropriate
the ALLL documentation to support the ALLL process and reported amounts.
The credit union should document the relationships between the results
of the credit union’s detailed review of the loan portfolio, the amount
of the ALLL, and the provision for loan and lease losses reported in
each period. Examiners should review the supporting documentation
over the following decisions, strategies, and processes:
Page 11-2
Policies and procedures over the systems and controls that

maintain an appropriate ALLL, and over the ALLL methodology;
0 Loan grading system or process (if applicable);
Summary or consolidation of the ALLL components;
0 Validation of the ALLL methodology; and
Periodic adjustments to the ALLL process.
Analysis of The following sections of this chapter provide guidance on significant

ALLL aspects of ALLL methodologies and documentation practices.
Specifically, this chapter addresses:
Application of GAAP,
Policies and procedures,
0 Methodology,
Summarizing components and consolidating the loss estimates
forming the amount required in the ALLL, and
0 Validating the ALLL methodology.
Application of GAAP-recorded ALLL quantifies a credit union’s best estimate of the

GAAP probable uncollectible amount of loans and leases based on current
information and events. Estimating the amount of the ALLL involves
management judgment and is inevitably imprecise.
Two GAAP rules primarily govern valuation of the ALLL. One covers
large balance non-homogeneous loans (FAS 114), usually business and
agriculture loans. The other rule deals with groups of homogeneous
pools of loans (FAS 5) such as credit card, residential mortgage and
consumer installment loans. The following further details those rules:
Business and agricultural loans. GAAP provides guidance on the

acceptable methods for measuring impairment for larger-balance
loans individually evaluated. Specifically, GAAP states that if
impairment of such a loan exists, a credit union should measure
impairment based on the following:
- The present value of expected future principal and interest cash

flows discounted at the loan’s effective interest rate;
Page 11-3
EXAMINER’S GUIDE
- A loan’s observable market price; or

- The fair value of collateral, if applicable.
When developing the estimate of expected future cash flows for a

loan, a credit union should consider all available information
reflecting past events and current conditions, including the effect of
existing environmental factors.
0 Credit Card, Residential Mortgage, and Consumer Installment

Loans. Credit unions collectively evaluate large pools of smaller-
balance homogeneous loans for impairment rather than evaluating
these pools on an individual basis. The pools may include
individually evaluated loans (business and agricultural above) that
the credit union does not consider individually impaired.
According to GAAP, a credit union should increase the ALLL when it

has incurred a probable loss and it can reasonably estimate the amount.
A credit union may determine that the amount of loss falls within a
range and may record its best estimate within the range of loan losses.
Examiners should ensure credit unions do not layer their loan loss
allowances. Layering occurs when the credit union inappropriately
records in the ALLL more than one amount for the same probable loan
loss. It can happen when a credit union includes a loan in one segment,
determines its best estimate of loss for that loan either individually or
in a pool, and then includes the loan in another pool, which receives an
additional ALLL amount.
Policies and The ALLL process requires a wide range of policies, procedures, and
Procedures control systems. Credit unions should tailor their policies to the size
and complexity of the credit union and its loan portfolio.
The effectiveness of a credit union’s ALLL methodology requires

written policies and procedures that, at a minimum, should address the
following:
The roles and responsibilities of the credit union’s departments and

personnel (including the lending function, credit review, financial
reporting, internal audit, senior management, board of directors,
~ ~~
Page 11-4
and others, as applicable) who determine, or review the ALLL they

will report in the financial statements;
The credit union’s accounting policies for loans and loan losses,
including the policies for charge-offs, recoveries, and estimating
the fair value of collateral (if any);
The description of the credit union’s methodology, which should

maintain consistency with the credit union’s accounting policies
for determining its ALLL; and
The system of internal controls used to ensure that the ALLL

process adheres to GAAP and supervisory guidance.
An internal control system for the ALLL estimation process should:
Include measures to ensure the reliability and integrity of

information and compliance with laws, regulations, and internal
policies and procedures;
0 Reasonably ensure that the credit union’s financial statements

(including regulatory reports) follow GAAP and ALLL supervisory
guidance;
Include a well-defined loan review process containing:
- An effective, consistently-applied loan grading system that

accurately, and in a timely manner, identifies differing risk
characteristics and loan quality problems, and prompts
appropriate corrective actions;
- Internal controls that ensure consideration of all relevant loan

review information in estimating losses. This includes
maintaining appropriate reports and details of reviews
performed, and identifying personnel involved; and
- Clear, formal communication and coordination between the

board of directors, management, and others involved in the
ALLL determination or review (e.g., written policies and
Page 11-5
EXAMINER’S GUIDE
procedures, management reports, audit programs, and

committee minutes.)
Methodology An ALLL methodology is a system designed and implemented by the

credit union to reasonably estimate loan and lease losses as of the
financial statement date. ALLL methodologies should incorporate
management’s current judgment about the loan portfolio’s credit
quality through a disciplined and consistently applied process.
A credit union’s size, organizational structure, business environment

and strategy, management style, loan portfolio characteristics, loan
procedures, field of membership, and management information
systems influence its ALLL methodology. While credit unions may use
different methods, certain common elements should exist in any ALLL
methodology. Generally, a credit union’s methodology should:
Include a regularly performed analysis of the loan portfolio

detailing delinquency, loan losses, extensions, etc., by loan type
andor category;
Consider all loans (whether on an individual or pool basis);
Identify loans for impairment evaluation on an individual basis

under FAS 114 and segment the remainder of the portfolio into
pools of loans with similar risk characteristics for evaluation and
analysis under FAS 5 (discussion of FAS 114 and FAS 5 occurs
later in this chapter);
Consider all known relevant internal and external factors that may
affect loan collectibility;
Apply factors affecting collectibility consistently (but modify for

new factors);
0 Consider the particular risks inherent in different kinds of lending;
Consider current collateral values (less costs to sell), where

applicable;
Page 11-6
Require performance of analyses, estimates, reviews, and other

ALLL methodology hnctions by well-trained personnel;
0 Base methodology on current and reliable data;
Require thorough documentation with clear explanations of the

supporting analyses and rationale; and
0 Include a systematic and logical method to summarize the balances

determined under the various methodologies and ensure the credit
union follows GAAP when recording the ALLL balance.
A properly designed and implemented methodology should provide a

credit union’s best estimate of the ALLL balance. Each dividend
period, credit unions should make necessary adjustments to the ALLL
account.
Documenting A credit union’s written policies and procedures should describe the
ALLL primary elements of its ALLL methodology, including portfolio
Methodology segmentation and impairment measurement. Effective policies and
procedures should describe the methodology:
For segmenting the portfolio:
- The credit union’s segmentation process (i.e., by loan type,

industry, credit scoring, etc.),
- The loan grading system used to segment the portfolio, if
applicable, including:
i. Definitions of each loan grade,

ii. Reconciliation of the credit union’s internal loan grades to
examiners’ concerns, and
iii. Delineation of responsibilities for the loan grading system.
For determining and measuring impairment for business and

agriculture loans (FAS 114):
Page 11-7
EXAMINER'S GUIDE
- The methods used to identifl loans for individual analysis;

- The methods by which the credit union determines and
measures the amount of impairment for individually reviewed
impaired loans, including:
i. Procedures describing available impairment measurement

techniques, and
ii. Steps performed to determine which technique most
appropriately fits a given situation.
- The methods used to determine whether and how the credit

union should pool business and agriculture loans deemed
individually evaluated, but not individually impaired, with
other loans that share common characteristics for impairment
evaluation under pools (FAS 5.)
0 For determining and measuring impairment for groups of consumer

and mortgage loans (FAS 5):
- Criteria for pooling loans with similar characteristics to

evaluate them for collectibility (such as loan type, past-due
status, and risk);
- Criteria for determining loss rates (e.g., historical loss rates
adjusted for environmental factors or migration analysis) and
time frames to evaluate loss experience; and
- Descriptions of qualitative factors (e.g., industry, geographical,
economic and political factors) that may affect loss rates or
other loss measurements.
The credit union may integrate supporting documents for the ALLL in
its credit files, loan review reports or worksheets, board of directors
and committee meeting minutes, computer reports, or other appropriate
documents and files.
Management should consider all known relevant internal and external

factors that affect loan collectibility as of the reporting date.
Management's current judgments about the credit quality of the loan
portfolio should determine the amounts of the ALLL and provisions
for loan and lease losses and should include the following:
Page 11-8
0 The board should review and approve the ALLL and provision for
loan and lease losses reported each period;
The board should periodically validate and, when necessary, revise
the methodology to ensure it remains appropriate for the credit
union;
0 The supervisory committee should oversee and monitor the internal
controls over the ALLL determination process;
0 The officials should adjust the allowance for loan and lease losses
through current earnings in accordance with GAAP; and
The officials should understand that they must meet the full and
fair disclosure requirements in 5702.402 of NCUA Rules and
Regulations before distributing dividends.
Allowance for In applying its ALLL methodology for business and agriculture loans,
Individual the credit union begins with its normal loan review procedures to
Impairment Of identify whether impairment of a loan exists. The credit union must
Large Balance,
document its method for identifying and analyzing impaired loans and
Non-
Homogeneous must retain that documentation. The analysis must include the
Loans (FAS 114) determination of which of the following measurement methods it
used:
0 Present value of expected future cash flows, including:
- The amount and timing of cash flows,

- The effective interest rate used to discount the cash flows, and
- The basis for determining cash flows, including consideration
of current environmental factors and other information
reflecting past events and current conditions.
0 Fair value of collateral less costs to sell, including:
- Criteria for determining fair value, including the use of

appraisals, valuation assumptions, and calculations,
- Supporting rationale for any adjustments to appraised values,
- Determination of costs to sell, if applicable, and
- Appraisal quality, and the expertise and independence of the
appraiser.
Page 11-9
EXAMINER'S GUIDE
0 Observable market price:

- The amount, source, and date of the observable market price of
the loan.
Examiners should understand that fully collateralized loans may

require no ALLL.
Documenting an ALLL for Individually Impaired Large Balance Non-

Homogeneous Loans (e.g., Business and Agricultural)
Comprehensive worksheetfor the impairment measurementprocess

A small credit union uses a comprehensive worksheet for each loan being reviewed
individually under FAS 114. Each worksheet includes a description of why the loan
was selected for individual review, the impairment measurement technique used, the
measurement calculation, a comparison to the current loan balance, and the amount
of the ALLL for that loan. The rationale for the impairment measurement technique
used (e.g., present value of expected future cash flows, observable market price of
the loan, fair value of the collateral) is also described on the worksheet.
I Illustration 11-A
Allowance for When evaluating loans on a pool basis under GAAP, management
SmallBalance should segment the loan portfolio by identifjing risk characteristics
Homogeneous common to various pools of loans. Credit unions typically decide how
pOO's Of Loans
to segment their loan portfolios based on many factors, which vary
(FAS 5)
with their business strategies as well as their information system
capabilities. Credit unions typically segment their portfolios as
follows:
0 Credit unions involved in less complex activities and offering a

narrow range of loan products often segment the portfolio into
broad loan categories.
0 Credit unions offering a more diverse and complex mix of loan

products may segment the portfolio into major loan types but
typically maintain more detailed information. This allows them to
further segregate the portfolio into product line segments based on
the risk characteristics of each portfolio segment.
Changes in economic and other business conditions often require

credit unions to modify their business strategies. This may result in
Page 11-10
flu
adjustments to the way in which they segment their loan portfolio for
purposes of estimating loan losses.
Regardless of the segmentation method used, a credit union should

maintain written documentation to support its conclusion that the loans
in each segment have similar attributes or characteristics.
Credit unions use a variety of documents to support the segmentation

of their portfolios, including:
0 Loan trial balances by categories and types of loans;

Management reports about the mix of loans in the portfolio;
Delinquency and non-accrual reports; and
0 A summary presentation of the results of an internal or external
loan grading review.
Credit unions may find reports generated to assess the profitability of a

loan product line useful in identifying areas in which to further
segment the portfolio.
Documenting Segmentation Practices
Documenting a refinement in a segmentation method.

A credit union with a significant portfolio of consumer loans performed a review of
its ALLL methodology. The credit union had determined its ALLL based upon
historical loss rates in the overall consumer portfolio. The ALLL methodology was
validated by comparing actual loss rates (charge offs) for the past two years to the
estimated loss rates. During this process, the credit union decided to evaluate loss
rates on an individual product basis (e.g., auto loans, unsecured loans, or home equity
loans.) This analysis disclosed significant differences in the loss rates on different
products. With this additional information, the methodology was amended in the
current period to segment the portfolio by product, resulting in a better estimation of
the loan losses associated with the portfolio. To support this change in segmentation
practice, the credit review committee records contain the analysis that was used as a
basis for the change and the written report describing the need for the change.
Illustration 11-B
Estimating Loss After segmenting the portfolio and using a systematic and consistently
on Pools of applied approach to select the most appropriate loss measurement
Loans methods, a credit union should estimate the required ALLL for each
L
segment (pool.) For those segments that require an ALLL, the credit
Page 11-11
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EXAMINER'S GUIDE
union should estimate the loan and lease losses, each dividend period,
based on its ongoing loan review process and loan performance
analysis.
One method of estimating loan and lease losses for pools of loans is by
applying loss rates to the pools' aggregate loan balances. Such loss
rates typically reflect historical loan loss experience for each pool of
loans, adjusted for relevant environmental factors (e.g., industry,
geographical, economic, and political factors) over a defined period of
time.
If a credit union does not have loss experience of its own, it may
reference the loss experience of other credit unions. To do so, it must
demonstrate similarity between the attributes of the loans in its
portfolio to those of the loans included in the portfolio of the credit
union providing the loss experience.
Documenting the Loss Measurement Method
Comprehensiveloss analysis in a small credit union

A small credit union determines its loss rates based on loss rates over a three-year
historical period. The analysis is conducted by type of loan and is m h e r segmented
by originating branch office. The analysis considers charge offs and recoveries in
determining the loss rate. The credit union also considers the loss rates for each loan
grade and compares them to historical losses on similarly rated loans in arriving at
the historical loss factor. The credit union maintains supporting documentation for its
loss factor analysis, including historical losses by type of loan, originating branch
office, and loan grade for the three-year period.
Adjustment of loss ratesfor changes in local economic conditions
A credit union develops a factor to adjust loss rates for its assessment of the impact
of changes in the local economy. For example, when analyzing the loss rate on
business real estate loans, the assessment identifies changes in recent commercial
building occupancy rates. The credit union generally finds the occupancy statistics to
be a good indicator of probable losses on these types of loans. The credit union
maintains documentation that summarizes the relationship between current
occupancy rates and its loss experience.
I Illustration 11-C
Credit unions should maintain supporting documentation for the

technique used to develop their loss rates, including the period of time
over which they incurred the losses. If credit unions use a range of
Page 11-12
loss, they should maintain documentation to support the identified

range and the rationale used for determining the best estimate within
the range of loan losses.
Before employing a loss measurement method, a credit union should

evaluate and modify, as needed, the method’s assumptions to ensure
consistency of the resulting loss estimate with GAAP. Credit unions
can demonstrate consistency with GAAP by documenting the
evaluation, the conclusions regarding the appropriateness of the loss
measurement method or other loss estimation tool, and the support for
adjustments to the method or its results.
In developing loss measurements, credit unions should consider the

impact of current environmental factors and document which factors
they used in the analysis and how those factors affect the loss
measurements. Credit unions should consider the following factors
when developing loss measurements:
Levels of and trends in delinquencies and impaired loans;

Levels of and trends in charge-offs and recoveries;
Trends in volume and terms of loans;
Effects of any changes in risk selection and underwriting standards,
and other changes in lending policies, procedures, and practices;
Experience, ability, and depth of lending management and other
relevant staff;
National and local economic trends and conditions;
Industry conditions; and
Effects of changes in credit concentrations.
Adjustments of loss measurements for environmental factors require

that the credit union maintain sufficient, objective evidence to support
the amount of the adjustment. The documentation must relate the need
for the adjustment to current information, events, circumstances, and
conditions.
Page 11-13
EXAMINER’S GUIDE
Summarizing Management should prepare a summary document supporting the

Components amount of ALLL it reports on the credit union’s financial statements.
and This will verifL that the ALLL is fairly presented in accordance with
Consolidating GAAP and is auditable. The credit union board should review and
the Amount approve this summary. Common elements in such summaries include:
of the ALLL
An estimate of the probable loss or range of loss incurred for each
category evaluated (e.g., individually evaluated impaired loans,
homogeneous pools, and other pools of loans collectively
evaluated for impairment);
The aggregate probable loss estimated using the credit union’s
methodology;
A summary of the current ALLL balance;
The amount, if any, of the necessary ALLL adjustment; and
Detailed sub-schedules of loss estimates that reconcile to the
summary schedule, if so warranted by the level of detail supporting
the ALLL analysis.
Generally, a credit union’s review and approval process for the ALLL
relies upon the data provided in these consolidated summaries.
However, instances may exist whereby individuals or committees that
review the ALLL methodology and allowance balance identifl needed
adjustments to provide a better estimate of loan losses. These changes
may result from information not known at the time of the initial loss
estimate.
Management should (1) document the nature of any adjustments and

the underlying rationale for making the changes, (2) ensure these
adjustments remain consistent with GAAP, and (3) make certain the
adjustments receive the review and approval of appropriate personnel.
They should provide this documentation to those making the final
determination of the ALLL amount. The summary should give each
subsequent reviewer an understanding of the support behind the
adjustments.
Va Iidating A valid ALLL methodology accurately estimates the amount of loss

ALLL contained in the portfolio. Thus, the credit union’s methodology
Methodology should include procedures that adjust loss estimation methods to
Page 11-14
reduce differences between estimated losses and actual subsequent

charge offs, as necessary.
To verify the validity of the ALLL methodology and its conformance

with GAAP and necessary supervisory guidance, the board should
establish internal control policies, appropriate for the size of the credit
union and the type and complexity of its loan products. These policies
should include procedures for a review, by a party independent of the
ALLL estimation process, of the ALLL methodology and its
application in order to confirm its effectiveness.
In practice, credit unions employ numerous procedures when

validating the reasonableness of their ALLL methodology and
determining whether deficiencies exist in their overall methodology or
loan grading process. Validation procedures include the following:
0 A review of trends in loan volume, delinquencies, restructurings,

and concentrations;
0 A review of previous charge-off and recovery history, including an
evaluation of the timeliness of the entries to record both the
charge-offs and the recoveries;
0 A review, on a test basis by a party independent of the ALLL
estimation process, of source documents and underlying
assumptions to determine that the established methodology results
in reasonable loss estimates; and
0 An evaluation of the appraisal process of the underlying collateral,
by periodically comparing the appraised value to the actual sales
price on selected properties sold.
Supporting Usually, management supports the validation process with the

Documentation working papers from the ALLL review function. Additional
for the Validation documentation often includes the summary findings of the
Process
independent reviewer. The credit union’s board of directors, or its
designee, reviews the findings and acknowledges its review in its
meeting minutes. If the officials change the methodology based upon
the findings of the validation process, they should maintain
documentation that describes and supports the changes.
Page 11-15
EXAMINER'S GUIDE
When a If required, a Document of Resolution (DOR) should focus on the

Document of methodology (deficiencies noted, improvements needed) rather than a
Resolution is specific dollar amount of over- or under-statement in the ALLL.
Required However, if the examiners detect a material misstatement, they should
require an appropriate dollar amount of funding.
and - ALLL
References - Loan Analysis
- Query Report Loans Impaired
- Allowance for Loan and Lease Losses Classification
- Allowance Summary
0 References
3 702.402 -- Full and Fair Disclosure
Page 11-16
ALLL FACTS, QUESTIONS, and ANSWERS =
APPENDIX I I A
Measuring Facts: Approximately one-third of Credit Union A’s business loan
and portfolio consists of large balance, non-homogeneous loans. Due to
Documenting their large individual balances, these loans meet the criteria under
Impairment Credit Union A’s policies and procedures for individual review for
Under FAS impairment under FAS 114. Upon review of the large balance loans,
114 Credit Union A determines that certain of the loans are impaired as
defined by FAS 114.
Question: For the business loans reviewed under FAS 114 that are
individually impaired, how should Credit Union A measure and
document the impairment on those loans? Can it use an impairment
measurement method other than the methods allowed by FAS 114?
Interpretive Response: For those loans that are reviewed

individually under FAS 114 and considered individually impaired,
Credit Union A must use one of the methods for measuring
impairment that is specified by FAS 114 (that is, the present value of
expected future cash flows, the loan’s observable market price, or
the fair value of collateral). Accordingly, in the circumstances
described above, for the loans considered individually impaired
under FAS 114, it would not be appropriate for Credit Union A to
choose a measurement method not prescribed by FAS 114. For
example, it would not be appropriate to measure loan impairment by
applying a loss rate to each loan based on the average historical loss
percentage for all of its business loans for the past five years.
Credit Union A should maintain written documentation to support its

measurement of loan impairment under FAS 114. If Credit Union A
uses the present value of expected future cash flows to measure
impairment of a loan, it should document the amount and timing of
cash flows, the effective interest rate used to discount the cash flows,
and the basis for the determination of cash flows, including
consideration of current environmental factors and other information
reflecting past events and current conditions. When Credit Union A
uses the fair value of collateral to measure impairment,
Page 11A-1
EXAMINER’S GUIDE
Credit Union A should document how it determined the fair value,

including the use of appraisals, valuation assumptions and
calculations, the supporting rationale for adjustments to appraised
values, if any, and the determination of costs to sell, if applicable,
appraisal quality, and the expertise and independence of the
appraiser. Similarly, Credit Union A should document the amount,
source, and date of the observable market price of a loan, if that
method of measuring loan impairment is used.
Measuring Facts: Credit Union B has a $750,000 loan outstanding to Member

Impairment X that is secured by real estate, which Credit Union B, according to
for a their current policy, individually evaluates under FAS 114 due to the
Collateral loan’s size. Member X is delinquent under the terms of the loan
Dependent agreement. Accordingly, Credit Union B determines that its loan to
Loan Under Member X is impaired, as defined by FAS 114. Because the loan is
FAS 114 collateral dependent, Credit Union B measures impairment of the
loan based on the fair value of the collateral. Credit Union B
determines that the most recent valuation of the collateral was
performed by an appraiser eighteen months ago and, at that time, the
estimated value of the collateral (fair value less costs to sell) was
$900,000.
Credit Union B believes that certain of the assumptions that were

used to value the collateral eighteen months ago do not reflect
current market conditions and, therefore, the appraiser’s valuation
does not approximate current fair value of the collateral. Several
buildings, which are comparable to the real estate collateral, were
recently completed in the area, increasing vacancy rates, decreasing
lease rates, and attracting several tenants away from the borrower.
Accordingly, personnel at Credit Union B adjust the valuation
assumptions to better reflect the current market conditions as they
relate to the loan’s collateral. After adjusting the collateral valuation
assumptions, the loan review department determines that the current
estimated fair value of the collateral, less costs to sell, is $575,000.
Considering the loan balance is $750,000, Credit Union B concludes
that the loan is impaired by $175,000 and records an ALLL
adjustment of $175,000.
Page llA-2
ALLL FACTS. QUESTIONS, AND ANSWERS - APPENDIX 11A
Question: What type of documentation should Credit Union B

maintain to support its ALLL adjustment of $175,000 for the loan to
Member X?
Interpretive Response: Credit Union B should document that it

measured impairment of the loan to Member X by using the fair
value of the loan’s collateral, less costs to sell, which it estimated to
be $575,000. This documentation should include the credit union’s
rationale and basis for the $575,000 valuation, including the revised
valuation assumptions it used, the valuation calculation, and the
determination of costs to sell, if applicable. Because Credit Union B
arrived at the valuation of $575,OOO by modifying an earlier
appraisal, it should document its rationale and basis for the changes
it made to the valuation assumptions that resulted in the collateral
value declining from $900,000 eighteen months ago to $575,000 in
the current period.
Fully Facts: Credit Union C has $500,000 in business loans that are fully
Collateralized collateralized by purchased business equipment. The loan agreement
Loans Under for each of these loans requires the borrower to provide qualifying
FAS 114 collateral sufficient to fully secure each loan. The member borrowers
have physical control of the collateral. Credit Union C perfected its
security interest in the collateral when the funds were originally
distributed. On an annual basis, Credit Union C determines the
market value of the collateral for each loan using two independent
market quotes and compares the collateral value to the loan carrying
value. Semiannually, or more frequently as needed, Credit Union C
physically inspects the equipment. If there are any collateral
deficiencies, Credit Union C notifies the borrower and requests that
the borrower immediately remedy the deficiency. Due in part to its
efficient operation, Credit Union C has historically not incurred any
material losses on these loans. Credit Union C believes these loans
are fully collateralized and therefore does not maintain any ALLL
reserve for these loans ~
Question: What documentation does Credit Union C maintain to

adequately support its determination that no allowance is needed for
this group of loans?
Page 11A-3
EXAMINER’S GUIDE
Interpretive Response: Credit Union C’s management summary of

the ALLL includes documentation indicating that, in accordance with
the credit union’s ALLL policy, the collateral protection on these
loans has been verified by the credit union, no probable loss has been
incurred, and no ALLL is necessary. Documentation in Credit Union
C’s loan files includes the two independent market quotes obtained
annually for each loan’s collateral amount, the documents evidencing
the perfection of the security interest in the collateral, and other
relevant supporting documents. Additionally, Credit Union C’s
ALLL policy includes a discussion of how to determine when a loan
is considered “fully collateralized” and does not require an ALLL.
Credit Union C’s policy requires the following factors to be
considered and the credit union’s findings concerning these factors to
be fully documented:
0 Volatility of the market value of the collateral;

0 Recency and reliability of the appraisal or other valuation;
Recency of the credit union or other third party inspection of the
collateral;
Historical losses on similar loans;
0 Confidence in the credit union’s lien or security position
including appropriate:
- Type of security perfection (e.g., physical possession of
collateral or secured filing);
- Filing of security perfection (i.e., correct documents and with
the appropriate officials), and
- Relationship to other liens.
Documentation indicating adequate and up to date insurance is in
effect for the secured collateral.
Other factors as appropriate for the loan type.
Adjusting Facts: Credit Union D’s field of membership (lending area) includes
Loss Rates a metropolitan area that is financially dependent upon the
Under FAS 5 profitability of a number of sponsor manufacturing businesses. These
businesses use highly specialized equipment and significant quantities
of rare metals in the manufacturing process. Due to increased low-
cost foreign competition, several of the parts suppliers servicing
these sponsor manufacturing firms declared bankruptcy. The foreign
suppliers have subsequently increased prices and the sponsor
Page llA-4
ALLL FACTS, QUESTIONS, AND ANSWERS - APPENDIX 11A
manufacturing firms have suffered from increased equipment

maintenance costs and smaller profit margins. Additionally, the cost
of the rare metals used in the manufacturing process increased and
has now stabilized at double last year’s price. Due to these events,
the sponsor manufacturing businesses are experiencing financial
difficulties and have recently announced downsizing plans.
Although Credit Union D has yet to confirm an increase in its loss

experience as a result of these events, management knows that the
credit union lends to a significant number of member’s for business
and individual purposes whose repayment ability depends upon the
long-term viability of the sponsor manufacturing businesses. Credit
Union D’s management has identified particular segments of its
business and consumer member bases that include member borrowers
highly dependent upon sales or salary from the sponsor
manufacturing businesses. Credit Union D’s management performs
an analysis of the affected portfolio segments to adjust its loss rates
used to determine the ALLL. In this particular case, Credit Union D
has experienced similar business and lending conditions in the past
that it can compare to current conditions.
Question: How should Credit Union D document its support for the
loss rate adjustments that result from considering these
manufacturing firms’ financial downturns?
Interpretive Response: Credit Union D should document its

identification of the particular segments of its business and consumer
loan portfolio for which it is probable that the sponsor manufacturing
business’ financial downturn may result in loan losses. In addition,
Credit Union D should support adjustments to the loss rates for the
affected portfolio segments. As part of its documentation, Credit
Union D maintains copies of the documents supporting the analysis,
including relevant newspaper articles, economic reports, and
economic data, and notes from discussions with individual member
borrowers. Because in this case Credit Union D has had similar
situations in the past, its supporting documentation should also
include an analysis of how the current conditions compare to its
previous loss experiences in similar circumstances. As part of its
effective ALLL methodology, Credit Union D creates a summary of
the amount and rationale for the adjustment factor, which
Page l l A - 5
ALLL FACTS, QUESTIONS, AND ANSWERS - APPENDIX 11A
Question: How does Credit Union E adequately support and

document an ALLL under FAS 5 for these loans that were
individually reviewed for impairment but are not considered
individually impaired?
Interpretive Response: As part of Credit Union E’s effective ALLL

methodology, it documents the decision to include its loans to
Member Y and Member Z in its determination of its ALLL under
FAS 5. It also documents the specific characteristics of the loans that
were the basis for grouping these loans with other loans in Segment
1 and Segment 2, respectively. Credit Union E maintains
documentation to support its method of estimating loan losses for
Segment 1 and Segment 2, including the average loss rate used, the
analysis of historical losses by loan type and by internal risk rating,
and support for any adjustments to its historical loss rates. The credit
union also maintains copies of the economic and other reports that
provided source data.
Consolidating Facts: Credit Union F determines its ALLL using an established

the Loss systematic process. At the end of each period, the accounting
Estimates- department prepares a summary schedule that includes the amount of
Documenting each of the components of the ALLL, as well as the total ALLL
the Reported amount, for review by senior management, the Credit Committee,
ALLL and, ultimately, the board of directors. Members of senior
management and the Credit Committee meet to discuss the ALLL.
During these discussions, they identify changes to be made to certain
of the ALLL estimates. As a result of the adjustments made by
senior management, the total amount of the ALLL changes.
However, senior management (or its designee) does not update the
ALLL summary schedule to reflect the adjustments or reasons for
the adjustments. When performing their audit of the financial
statements, the independent accountants are provided with the
original ALLL summary schedule that was reviewed by management
and the Credit Committee, as well as a verbal explanation of the
changes made by senior management and the Credit Committee when
they met to discuss the loan loss allowance.
Page llA-7
EXAMINER'S GUIDE
Question: Are Credit Union F's documentation practices related to

its ALLL balance appropriate?
Interpretive Response: No. A credit union must maintain supporting

documentation for the ALLL amount reported in its financial
statements. As illustrated above, there may be instances in which
ALLL reviewers identify adjustments that need to be made to the
loan loss estimates. The nature of the adjustments, how they were
measured or determined, and the underlying rationale for making the
changes to the ALLL balance should be documented. Appropriate
documentation of the adjustments should be provided to the board of
directors (or its designee) for review of the final ALLL amount to be
reported in the financial statements. For credit unions subject to
external audit, this documentation should also be made available to
the supervisory committee and its independent accountants. If
changes frequently occur during management or committee reviews
of the ALLL, management may find it appropriate to analyze the
reasons for the frequent changes and to reassess the methodology the
credit union uses.
Page llA-8
Chapter 12
INVESTMENT ANALYSIS
TABLE OF CONTENTS
INVESTMENT ANALYSIS ........................................................................................... 12-1

Examination Objectives....................................................................................... 12-1
Overview .............................................................................................................. 12-1
Examiner Resources............................................................................................. 12-2
Policies ................................................................................................................. 12-2
Examination Guidance ......................................................................................... 12-9
Classification of Securities SFAS 115 ................................................................. 12-10
Broker-Dealer Analysis ........................................................................................ 12-11
Audit .................................................................................................................... 12-14
Safekeeping.......................................................................................................... 12-14
Records ................................................................................................................ 12-17
Investment Valuation ........................................................................................... 12-18
Bond Basics ......................................................................................................... 12-19
Principal ................................................................................................... 12-20
Coupon Rate............................................................................................. 12-20
Day Count Basis....................................................................................... 12-21
Accrued Interest ....................................................................................... 12-21
Price Quotations....................................................................................... 12-22
Yield Quotations ...................................................................................... 12-23
Investment Products ............................................................................................. 12-23
..
US Treasury Securities............................................................................. 12-24
Treasury Bills ........................................................................................... 12-24
Treasury Notes and Bonds ....................................................................... 12-25
Treasury Zeros or STRIPS ....................................................................... 12-25
Other US Guaranteed Securities .............................................................. 12-26
..
Federal Agency Secmties.................................................................................... 12-26
Government Corporations........................................................................ 12-26
Government Sponsored Enterprises ......................................................... 12-27
Obligations............................................................................................... 12-28
. . .
Participations............................................................................................ 12-28
Secondary Participations.......................................................................... 12-30
GNMAs .................................................................................................... 12-31
SBA Guaranteed Loans............................................................................ 12-33
Zero Coupon Bonds ................................................................................. 12-34
SMBS 10s and POS.................................................................................. 12-35
CMOS....................................................................................................... 12-37
REMIC ..................................................................................................... 12-41
INVESTMENT ANALYSIS
IRPS 98-02 ................................................................................................ 2-41

. . ........................................................................... 12-44
Divestiture of Securities
Residual Interests ..................................................................................... 12-46
Fair Values ............................................................................................... 12-46
Investment in Mortgage Notes ................................................................. 12-46
Mutual Funds, Common Trusts, Unit Trusts ....................................................... 12-46
Legality of Fund ....................................................................................... 12-47
Characteristics and Risks ......................................................................... 12-48
Fees ........................................................................................................... 2-49
Unit Investment Trusts............................................................................. 12-49
CUSOS................................................................................................................. 12-50
Federal Funds ....................................................................................................... 12-50
Credit Risk ............................................................................................... 12-51
Corporate Credit Unions ...................................................................................... 12-51
Other Credit Unions ............................................................................................. 12-53
Other Shares, Deposits, and Certificates.............................................................. 12-53
Thrift Shares and Bank Deposits ............................................................. 12-53
Time Certificates of Deposit ................................................................... 12-54
Deposit Notes ........................................................................................... 12-56
Bank Notes ............................................................................................... 12-56
Eurodollar Deposits ................................................................................. 12-56
Yankee Deposits ...................................................................................... 12-56
Bankers' Acceptances ............................................................................... 12-57
Mutual Savings Banks, State Banks, Trust Companies ........................... 12-57
Loans to Other Credit Unions .............................................................................. 12-57
. .
State and Municipal Obligations .......................................................................... 12-58
Repurchase Transactions..................................................................................... .l 2-58
Commitments to Purchase or Sell Securities ....................................................... 12-59
Standby Commitment .............................................................................. 12-60
Cash Forward Agreement ......................................................................... 2-60
Short Sale ................................................................................................ .l 2-60
Pair-Off Transactions............................................................................... 12-61
Reverse Repurchase Transactions........................................................................ 12-61
Adjusted Trading ................................................................................................. 12-63
Impermissible or Unsuitable Investments............................................................ 12-64
Investment Trading ............................................................................................... 2-65
APPENDIX 12A - GLOSSARY OF INVESTMENT TERMS ....................................... 12A-1
Chapter 12
INVESTMENT ANALYSIS
Examination Determine adequacy of the credit union’s investment policy,
Objectives procedures, and internal controls
Assess legality of investments and compliance with related
regulations, accounting procedures, and other guidelines
0 Evaluate suitability of the investment portfolio in relation to the
credit union’s business plan, asset-liability management (ALM)
strategies, liquidity, and net worth position
Determine fair value of the investment portfolio and the effect of
realized or potential losses from investment transactions on the
credit union’s earnings and capital position
0 Review correction of investment-related problems by management
Associated The investment area affects all seven risks found in credit union
Risks operations - credit, interest rate, liquidity, transaction, compliance,
strategic, and reputation. (The Risk-Focused Program chapter contains
a description of the seven risks faced by credit unions.) This chapter
specifically addresses credit, interest rate, liquidity, transaction,
compliance, and other operational risks; however, if credit unions
suffer significant losses due to investment decisions, the credit union
could also face reputation risk. Examiner’s judgment plays an
important role in identifying both the type and extent of risks as well
as deciding on appropriate examination procedures.
Overview The investment portfolio serves as an important source of liquidity and

can represent a substantial portion of a credit union’s assets. Likewise,
investment income can serve as an important source for meeting a
credit union’s operating expenses, dividend payments, and reserve
requirements (if applicable.) Thus, the examiner’s assessment of
management’s ability to invest prudently is an important part of the
examination.
The extent of the examiners’ investment reviews will depend on the

following:
Page 12-1
EXAMINER’S GUIDE
The results of reviews of investment policies, procedures,

practices, and internal controls;
The adequacy of management’s risk monitoring system for
investments;
The condition of investment records;
The volume and materiality of investment transactions; and
The degree of problems disclosed by previous audits or
examinations.
Examiners record the extent of the investment analysis (if they perform
such an analysis) in the Scope Workbook. They should also complete
applicable investment questionnaires or reports.
Examiner The key investment references for this chapter are NCUA Rules and
Resources Regulations 8703, IRPS 98-02, and related Guidance Papers. Other
resources that may assist examiners in their analysis of complex
investment portfolios include:
Regional capital market specialists (RCMS) in each regional office

provide technical assistance;
Bloomberg terminal, an information vendor system available
through each RCMS, provides investment characteristics and
analysis;
Office of Strategic Program Support and Planning (OSPSP) in the
Central Office provides additional assistance (examiners should
follow regional procedures);
The NCUA Investment Hotline (1 -800-755-5999) provides
examiners and credit unions a resource to call and discuss
investment questions.
Policies The board of directors must (1) adopt a written investment policy
consistent with the Federal Credit Union Act, N U J A Rules and
Regulations, and other applicable laws; and (2) review and update the
investment policy at least annually. A monitoring and reporting
program helps ensure the credit union’s investment process adheres to
the written policy. If the investment review discloses exceptions to
sound investment policies or procedures, the examiner will
recommend appropriate changes to resolve the concerns.
Page 12-2
INVESTMENT ANALYSIS
The credit union’s size and asset mix determine the scope of the
investment policy. At a minimum, the policy must address the
following:
0 Purpose and objectives. The credit union must document its

intentions (purpose) at the time it purchases investment securities,
and must classify each security as one of the following: held-to-
maturity, available-for-sale, or trading. SFAS 1 15 contains
additional guidance.
Investment objectives should reflect the relative importance of

investments to the credit union’s overall goals and objectives.
Generally, credit unions attempt to balance the need for safety and
liquidity against the need for yield, while maintaining enough
flexibility to respond to rapid changes in market interest rates.
Thus, investment objectives should closely coincide with internal
asset-liability goals and the short- and long-term business plan.
0 Characteristics of investments. Investment characteristics

describe the permissible investments and explain their pros and
cons. The board of directors must specify in the investment policy
the types and characteristics of investments permitted for the credit
union. Characteristics may include the issuer, maturity, coupon
rate, index, cap, floor, coupon formula, call provisions, average
life, and interest rate risk (e.g., duration.) For example, a board
policy specifying permissible interest rate risk (IRR) of an
investment communicates to management the board’s tolerance for
risk at the instrument level. The policy should ensure management
considers the effect of investment characteristics on the
marketability and resale value of the investment and the credit
union’s ability to achieve established liquidity objectives.
0 IRR. IRR is the potential for change in the value of a security as

market interest rates change (also referred to as market risk.)
Changes in interest rates can reduce the investment’s value.
Managing IRR on a total balance sheet basis, which includes
monitoring the price sensitivity of the investment portfolio and
long-term loans, is a sound business practice. A credit union may
consider whether it should specify institution-wide IRR limits
(generally for net economic value or earnings exposures) in light of
Page 12-3
EXAMINER’SGUIDE
its long-term investment and lending activities and its level of

capital.
Credit unions, especially those that do not establish institution-

wide IRR limits, may choose to establish price sensitivity limits on
their investment portfolio or individual investments. The officials
must understand that, while many investments have good
marketability, the selling price of an investment may be sensitive
to changes in interest rates. For example, although Treasury
securities usually have ready marketability, longer-term fixed-rate
Treasury securities generally will experience greater price
volatility than shorter-term fixed-rate Treasury securities.
Management must prepare a risk report at least quarterly if the fair

value of all securities with (1) embedded options, (2) maturities
greater than three years, or ( 3 ) complex coupon formulas
exceeding net capital. The risk report must document potential
effects of interest rate shifts of plus and minus three percent (300
basis points) on each security’s fair value and the cumulative effect
of those shifts on capital (9703.90.)
Liquidity risk. An investment’s liquidity or marketability risk is

the risk that inadequate market depth could impede the credit
union’s ability to promptly sell the investment at a reasonable or
fair market price. Generally, Treasury securities have greater
liquidity than other securities. Wide bid-ask spreads characterize
illiquid securities. Current examples of illiquid securities include
Small Business Administration (SBA) loan participation
certificates and smaller or older mortgage-backed securities
(MBS.) Additionally, negotiable CD investments in financially
weak depository institutions often are less liquid than investments
in strong depository institutions.
A credit union must have sufficient liquid assets to meet immediate

cash demands. The board should consider current and future
liquidity needs based on its business plan (including budget) and
asset-liability management strategy. The board should structure the
investment portfolio to help meet normal liquidity needs, as well as
any unexpected cash outflows.
Page 12-4
INVESTMENT ANALYSIS
Proper classification of held-to-maturity, available-for-sale, and

trading securities can enable a credit union to meet its liquidity
needs without an accounting reclassification. The examiner may
question a credit union’s assertion that it has the intent and ability
to hold securities to maturity if the credit union has had to sell or
transfer held-to-maturity securities to meet a liquidity need,
especially in instances of a material sale or transfer.
0 Credit risk. Credit risk is the possible loss that could occur if the
issuer of an investment defaults or if the market value of an
investment declines because the market perceives an increased
probability of default. Credit risk appears most often in uninsured
deposits with other (correspondent) financial institutions (e.g., Fed
Funds sold.)
Credit unions should address credit risk in their investment policies

as follows:
- List specific permissible institutions, issuers, and counter-

parties or specify criteria for their selection, &
- Specify limits on the dollar amounts the credit union may
invest in each.
Before making investments that exceed an insured limit, are not

insured, or not fully guaranteed as to principal and interest by the
U.S. Government or its agencies, enterprises, or corporations,
management must perform and document a credit analysis of the
investments. Management must update the analysis at least
annually as long as the credit union holds the investment. Smaller
credit unions that cannot perform a detailed credit analysis should
invest funds in appropriate alternatives (e.g ,, corporate credit
unions), albeit, they still must perform due diligence.
0 Concentration risk. Concentration risk results when the credit

union does not properly address diversification in the investment
portfolio. Concentration risk can occur when the investments in a
portfolio have similar characteristics, such as identical call dates
and provisions, the same or related issuers, or the same geographic
distribution. Concentrations in investments can increase a credit
union’s exposure to interest rate, credit, and liquidity risk. The
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EXAMINER'S GUIDE
investment policy should specify dollar limits for holdings of

obligations with similar characteristics (e.g., fixed vs. variable,
type of floating rate index, geographical distribution, etc.)
Delegation of authority to officials or employees. The credit

union board of directors may delegate the authority, but not the
responsibility, for making investment decisions. The board must
retain ultimate responsibility. The board may authorize an official
of the credit union (normally the president or an investment
officer) to invest or divest funds according to the investment policy
on a continuing basis. For example, the policy may authorize the
manager to transfer funds to an overnight investment account
whenever the checking account cash balance exceeds a specified
amount or average daily balance. Board policy must state explicitly
the authority it has delegated to the manager; §703.30(g) requires
professional qualifications by education or experience for
individuals given investment authority.
In other situations, the board may delegate only limited authority

to a credit union employee (e.g., complete and sign the necessary
papers related to investment transactions.) The board should
sufficiently define the delegation of authority so the individual
receiving the investment instructions cannot exercise discretionary
powers. This individual should report all transactions to the board,
investment committee, or executive committee at least monthly.
Board policies and procedures should address how the credit union
will comply with $703.120 (e.g., the prohibition on acceptance of
cash bonuses, merchandise premiums, etc., from broker-dealers.)
Delegation of authority to a third-party. $703.40(c) permits the

board to delegate its authority for investing credit union funds to a
third party. However, the credit union must ensure that the third
party is an investment adviser registered with the Securities and
Exchange Commission (SEC), and limit the aggregate amount of
such delegations (e.g., dollar amount of investments) to 100
percent of net worth. This restriction does not apply to investments
in mutual funds. Also, the 100 percent limitation does not apply to
credit unions meeting the Reg Flex requirements of Part '742.
INVESTMENT ANALYSIS
0 The board should exercise caution when delegating investment

decision authority to SEC-registered investment advisers. The
board should perform the following additional procedures:
- Investigate the integrity and financial condition of any

investment adviser before delegating investment authority;
- Reduce the delegation of authority to writing and explicitly
state in board policy the authority delegated to the investment
adviser; and
- Understand that the board must set policy limits, approve
procedures, understand the overall risks associated with the
investments, and receive reports assessing whether the
portfolio has remained within established limits.
0 Broker-dealer. A federal credit union may use a third party (i.e., a

broker-dealer) to purchase and sell investments if the broker-dealer
holds a current registration as a broker-dealer with (1) the SEC or
(2) a depository institution for which a federal regulatory agency
regulates the broker-dealer activities. CUSOs that provide broker-
dealer services to credit unions must meet the requirements of
5703.50.
A credit union making an investment in a certificate of deposit

(CD) must either send funds directly to the issuing depository
institution or use a broker-dealer. A federal credit union may use a
third party (i.e., a CD finder) to locate institutions offering high
CD rates, and may compensate the finder for that service, but it
must send the funds directly to the depository institution offering
the CD and not through the finder. (Refer to the section of this
chapter on Broker-Dealer Analysis; Letter to Credit Unions No.
157, September 1994; and Letter to Credit Unions No. 00-CU-05,
September 2000 for additional guidance.)
0 Safekeeping. Either the SEC or a federal or state depository

institution regulatory agency must regulate and supervise any
safekeeping institution that a federal credit union uses for custody
of purchased investments. Actual or opportunity losses can result
from inappropriate safekeeping arrangements for investments.
(Refer to the section ofthis chapter on Safekeeping for guidance.)
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EXAMINER’S GUIDE
Surveillance and divestiture. For investments that fail to meet the

requirements of the FCU Act, NCUA Rules and Regulations, or
board policy, the policy must address how the credit union will
handle these investments. The policy should include provisions for
monitoring and reporting of high-risk investments.
0 Trading account. Federal credit unions engaging in investment

trading must adopt expanded policies that address the trading issue,
and sufficient resources, knowledge, systems, and procedures to
manage the risks. The policy should address size limitations of the
trading account, stop loss or sale provisions, and limits on the
length of time the credit union may hold an investment in the
trading account.
0 Operational risks. In addition to the requirements above, credit

unions’ investment policies should address the various types of
risks inherent in the investment process, including:
- Management risk. Management risk is the loss potential

resulting from lack of knowledge about various characteristics
of the intended investment instrument. Before making any
investment, management must thoroughly understand the
intended security and ensure that the investment’s risk
characteristics are consistent with the credit union’s overall
investment objectives and business goals. Management’s
unfamiliarity with the pricing of an investment or terms of the
investment transaction can result in losses if the price
management paid exceeds the fair value. Therefore,
management must understand how the investment instrument
reacts to changes in market interest rates.
- Transactional or operational risk. This risk arises from

deficiencies in information systems or internal controls that can
result in unexpected loss. Sources of operational risk include
inadequate procedures, human error, system failure, and fraud.
The first line of defense in controlling operating risks is
effective internal controls, including separation of duties and
supervision of persons executing investment transactions from
those responsible for processing transactions and accounting
for investments; and
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INVESTMENT ANALYSIS
- Compliance or legal risk. Federal credit unions must ensure

that investments comply with the FCUAct, NCUA Rules and
Regulations, and other applicable laws. Legal risk includes the
risk that contracts, such as custodial agreements and repurchase
agreements, are not legally enforceable or properly
documented. Federal credit unions should adequately evaluate
agreements before entering into a contract to ensure (1)
compliance with applicable laws, and (2) inclusion of all
bargained for duties and provisions, such as the ordinary duty
of care for a safekeeper, or the requirement for a perfected first
priority security interest in repurchase collateral.
During the review of the board and the executive committee minutes,
examiners should determine that the board fulfills its responsibilities
and that any individual to whom the board has delegated its authority
submits the proper reports. Board minutes should clearly outline to
whom the board has delegated authority and the extent of that
authority. Examiners should review such delegations during each
examination.
In summary, credit unions can reduce investment risks by:
0 Fully evaluating each type of investment before purchase,

including the creditworthiness and/or the financial condition of the
issuer and the potential IRR of the proposed investment;
0 Analyzing the financial condition and reputation of any
intermediary to the transaction, such as a broker-dealer; and
0 Diversifying the investment portfolio by type, maturity,
geographical location, guarantor, etc.
Examination Examiners should complete the “Investment Controls” questionnaire

Guidance before determining the extent of investment risk. The examiner may
decide to expand the review if (1) the credit union has changed its
investment policies since the last examination, (2) the examiner or
auditor noted investment internal control or other weaknesses, (3) the
credit union changed substantially its investment mix, or (4) the credit
union has material amounts of complex investments in its investment
portfolio.
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EXAMINER'S GUIDE
If the examiner and supervisory examiner determine the necessity of

reviewing investments, the examiners should sample each investment
type. For example, if the credit union has 100 CDs, the examiner may
review a sample of five CDs. If problems exist, examiners should
expand their analysis to the point of determining the severity of the
problems and developing plans for correction.
Examiners may review brokeddealer activity, when applicable, to

determine the existence and extent of any resulting problems.
Examiners may also review a sample of investments made through a
new brokeddealer.
Classification Federal credit unions must report securities in accordance with

of Securities generally accepted accounting principles (GAAP), which require
SFAS 115 categorizing a security in one of three classifications:
0 Trading securities - debt and equity securities that the credit

union bought and holds primarily for the purpose of selling in the
near term (held for only a short period of time.) The credit union
reports trading securities at fair value through the income
statement;
0 Held-To-Maturity securities - debt securities that the credit union

has the positive intent and ability to hold to maturity. The credit
union reports held-to-maturity securities at amortized cost; and
0 Available-For-Sale securities - debt and equity securities not

classified as either trading or held-to-maturity securities. Credit
unions report available-for-sale securities at fair value through a
separate component of equity on the balance sheet, Accumulated
Unrealized Gains/Losses on Available-for-Sale Securities.
Absent evidence to the contrary, examiners normally should accept the

credit union's designations, especially if the examiner considers the
external audit adequate and does not take exception. (Contradictory
evidence could include a pattern of intermittent sales or transfers of
held-to-maturity securities, suggesting that the securities are actually
available-for-sale.) The examiner should foeus on evaluating the risks
Page 12-10
INVESTMENT ANALYSIS
in the securities holdings and activities and on the credit union’s

management of these risks, and should not micro manage the
classification of securities under SFAS No. 115. (Refer to SFAS 115
for further information.)
Broker-Dealer Following are recommended guidelines for credit unions to analyze

Analysis and select a broker-dealer:
0 Use only established, well-capitalized, registered broker-

dealers. The board should use established, well-capitalized, and
reputable national and regional firms, and should establish
minimum capital standards for each broker-dealer. If available, the
credit union should consider reports and credit ratings from one or
more of the nationally recognized statistical rating organizations
(e.g., Moody’s, Standard & Poor’s, or Fitch.)
Management should ensure the broker-dealer is either (1)

registered with the Securities and Exchange Commission under the
Securities Exchange Act of 1934 or (2) is a depository institution
whose broker-dealer activities are regulated by a federal regulatory
agency. For unregulated firms, the examiner should determine that
the credit union only obtains information from the unregulated
firms (e.g., a CD finder), but does not send funds through such
firms.
Management should regularly review the financial strength of the

broker using the broker’s latest audited financial statements,
paying particular attention to the capital and leverage positions,
such as notes payable and securities purchased on margin (see
Letter to Credit Unions No. 157.)
0 Check references and complaints against the firm and broker.

Management should perform a background and reputation check
on broker-dealers with whom the credit union does business (see
Letter to Credit Unions, No. 157, dated September 1994.) A
background check includes requesting and reviewing three to five
references from the salesperson and the firm, and inquiring of other
credit unions, chapters, and leagues about the broker-dealer and
firm.
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EXAMINER'S GUIDE
For each firm with which the credit union does or plans to do
business, the board should specifically request and obtain a written
response confirming or denying if the SEC, the National
Association of Securities Dealers (NASD), or a state securities
regulator has sanctioned either the firm or its salespeople in the last
five years. The board should perform the same due diligence on
each salesperson and confirm the responses with the SEC or
NASD (www.nasdr.com) and the applicable state securities
regulator. The credit union should obtain a broker-dealer
registration statement from NASD before doing business with any
individual.
NASD Regulation (NASDR) provides an online Public Disclosure

Program. Using the NASDR's Central Registration Depository
(CRD) the credit union can access broker-related background
information. Each broker-dealer firm and registered representative
has a unique CRD number, which it must provide upon request.
Credit unions can use the CRD number to reference background
information from NASDR.
Ascertain information about the knowledge, experience, and

performance of the broker. Management should inquire about the
salesperson's knowledge and skills, obtain a resume, and determine
what training the firm provides its salespeople. Most reputable
firms have schools or require periodic training.
On a continuing basis, management should analyze the overall

performance of the broker (e.g., review the number of times the
broker provided the lowest cost offer on securities purchased.) The
credit union should not do business with salespeople who do not
explain in depth the type of security they are offering for sale.
Most reputable firms provide salespeople with research and
analysis reports that explain the investment products.
Obtain competitive bids and offers. Credit unions should obtain

competitive bids and offers from more than one broker. Before
purchasing or selling a security, management must procure either
(1) price quotations on the security from at least two broker-dealers
or (2) a price quotation on the security from an industry-recognized
information provider (e.g., Bloomberg, Reuters, etc.) This
Page 12-12
INVESTMENT ANALYSIS
information is not required for new issues either purchased at par

or at an original issue discount (e.g., a U.S. Treasury Note
purchased at a discount at auction.) To ensure the credit union
receives a fair market price, management should consider
obtaining three independent quotations before purchasing or selling
a security.
If management cannot procure multiple offers from different

brokers to sell a security to the credit union, they should determine
the liquidity of the investment (e.g., will other brokers provide a
bid on the security) and whether the offer represents fair value
before committing to purchase it. The lack of multiple bids from
brokers to purchase a security from a credit union may indicate an
illiquid security (e.g., often, only the originating dealer bids on a
privately placed collateralized mortgage obligation (CMO)). The
credit union should try to confirm that the sole bid represents fair
value. For example, the credit union may request bids on
comparable securities (those with substantially similar
characteristics), retaining reasonable and appropriate
documentation (e.g., dated telephone note with quote from broker
or dated Wall Street Journal quote on specific comparable
security.) Brokers generally do not provide written bids.
0 Prepare a board resolution and list of limitations. The board

must maintain an internal list of board-approved broker-dealers,
including a list of limitations on the amount of funds and types of
securities that management or staff may place or invest with each
firm. In addition, the board should possess a written agreement
with each broker-dealer that specifies the type of securities,
transactions approved, and the approved amount for each firm and
individual broker. The board should acquire and maintain a basic
understanding of the business structure of the broker-dealer
including the primary emphasis of the firm (e.g., government
securities, agency securities, CMOS,retail, etc.)
0 Use a recorded phone line. Examiners should encourage credit

unions with active or very large investment portfolios to maintain a
separate, recorded phone line to document trading instructions and
retain a record of conversations with the broker-dealer. Before the
officials record conversations with a broker-dealer, they should
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EXAMINER'S GUIDE
exercise due diligence by addressing relevant legal and contractual

issues.
A credit union's reliance on Securities Investor Protection C o p

(SIPC) insurance does not substitute for a thorough review of the
broker-dealer. If available, SIPC insurance covers only the first
$500,000 of covered securities and cash. Many broker-dealers and
custodians obtain private insurance to cover losses in excess of the
SIPC limit. However, record keeping problems, fraud, disputed
amounts, or ineligible investments (e.g., rep0 agreements) may prevent
collection in full from the SIPC or private insurer.
Letter to Credit Unions, No. 157, contains additional information on

broker-dealer analysis. See also, $703.50 and the investment guidance
paper.
Audit Examiners should review the supervisory committee audit to

determine whether the auditor verified investments and if material
deficiencies were present in the investment area. The auditor bases the
extent of the verification of investments on the audit scope and
computed materiality level. Examiners should review the scope and
computed materiality level for reasonableness. Verification of
investments requires the auditor to either physically inspect the
investments or send confirmation letters. If the auditor did not verify
investments, the examiner should arrange to have the committee
perform the verification within a reasonable period, usually 60 days.
Examiners should not make a physical inspection or send verification
letters unless they suspect a problem and need the inspection or the
verification to support an examiner's finding. Examiners should
consult with the supervisory examiner before sending out
confirmations.
Safekeeping The credit union should have a procedure to ensure safekeeping of its
investments, as well as a board-approved list of safekeeping facilities.
Examiners should emphasize to the officials the importance of
safekeeping investments off the credit union's premises and enforcing
necessary internal controls to minimize the possibility of loss.
Investment losses can materially affect the credit union's financial
Page 12-14
IN VESTMENT ANALYSIS
condition. While some credit unions eventually recover part or all of

such losses, the legal process can make recovery very time consuming.
The credit union must retain a written custodial agreement with third
parties that act to safekeep the credit union’s investments (5703.60.)
As custodians, these third-party institutions safekeep the credit union’s
securities and will deliver them only after receiving the credit union’s
instruction.
Under $703.60, the custodial agreement is a contract in which a third

party agrees to exercise ordinary care in protecting the securities held
in safekeeping for its customers. Ordinary care, often called reasonable
or due care, holds the custodians responsible for losses from their acts
or omissions such as willful misconduct, bad faith, or negligence. A
custodial agreement must not specify a duty of care less than ordinary
(e.g., an agreement is insufficient if it holds the custodian responsible
for losses only from gross negligence.) If the custodial agreement
specifies no standard of care, credit unions may assume the default of
due care under the model Uniform Commercial Code 558-504-506.
The regulations require a custodial agreement for most securities. The

credit union must obtain monthly statements from the custodian to
verify its investments and repurchase collateral. The custodial
agreement should not restrict or alter the negotiability of any
investment. For example, the agreement should not restrict a
negotiable CD to safekeeping with a single custodian.
There are two situations that do not require a custodial agreement: (1)
investments that the credit union holds (possesses) in physical form
(most issuers now issue securities in book-entry form only) and (2)
book-entry investments recorded directly in the credit union’s name
through the Federal Reserve Book-Entry System. However, most
credit unions use a custodian to hold their investments recorded in the
custodian’s name through the Federal Reserve Book-Entry System.
Book-entry investments may include Treasury and Agency securities,
as well as mortgage derivative products such as agency CMOS,
Finally, as with other book-entry or physical securities, professional
third-party control minimizes the possibility of loss.
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EXAMINER'S GUIDE
Credit unions should ensure that at least two people approve the
transfer of any of its investments. Both delivery versus payment (DVP)
transactions and free deliveries (i.e., a transfer of a security without
payment) require this dual control measure. Two common uses for free
delivery include (1) transfer of securities from a primary custodian to a
third-party custodian in a tri-party repurchase agreement and (2)
transfer of securities from an old to a new custodian.
When a broker-dealer serves as safekeeper of the credit union's

investments, the written custodial agreement should assure the credit
union that the broker-dealer has segregated the credit union's securities
from the broker-dealer's investments and that the broker-dealer
maintains separate records for the credit union's investments. Officials
should review the custodial agreement (sometimes part of the account
agreement) to determine that it prohibits the broker-dealer from
lending the credit union's securities in the marketplace (e.g.,
hypothecation.) The credit union should carefully review the
reputation and financial stability of a broker-dealer serving as
custodian.
Officials must verify these custodial provisions. Credit unions can

sustain losses in securities held by broker-dealers. For example, a
brokerage firm could use a credit union's securities as collateral on its
own loans and later enter bankruptcy. A properly executed third-party
custodial agreement could prevent losses resulting from a credit union
forwarding funds to a broker but the broker failing to purchase the
security.
A safekeeping receipt must evidence each investment held by a third-

party custodian. The receipt generally contains the following
information, as it applies to the type of investment:
0 Name and CUSIP (Committee on Uniform Securities Identification

Procedures) identification o f the security,
Par value,
0 Date of issue,
0 Date of maturity and call date (if applicable),
0 Coupon or interest rate,
Coupon or interest payment dates,
Page 12-16
INVESTMENT ANALYSIS
0 Trade and settlement date, and

0 Name of beneficial owner.
The credit union can determine evidence of safekeeping with a broker-

dealer by reviewing the monthly broker statement. The last item on the
statement, often referred to as “inventory” or “position”, generally
lists the securities that the broker-dealer holds for the account.
Regardless of the methods the credit union uses to control its evidence
of beneficial ownership of investments or physical investment
documents, the credit union must have procedures in place to
periodically inspect and reconcile the actual documents, statements,
and safekeeping receipts to its records. When the credit union is the
beneficial owner of securities held by a custodian, the credit union’s
name does not appear on the book-entry system or on a physical
security. Thus, the credit union must verify records received from the
safekeeper with the credit union’s own records ($703.60.)
The credit union must require the selling broker to settle investment
transactions delivery versus payment (DVP.) DVP (also termed “cash
on delivery” and “delivery against cash”) provides for the
simultaneous transfer of funds and securities, ensuring that the credit
union (or its custodial agent) possesses either the securities or funds.
If the credit union requires the selling broker to settle investment

transactions at a third-party custodial agent, it may eliminate some of
the risk associated with settling and safekeeping securities. Delivery to
a third-party custodian may reduce problems with non-delivery of
securities, delivery of the wrong securities, purchase of nonexistent
securities, purchase of CDs based on inaccurate or partial disclosure of
terms, and other problems.
Records While all credit unions must maintain adequate investment records, the
sophistication of these records will depend on the level of activity and
the types of investments involved. For example, a credit union that
invests only in a common trust fund account could maintain this
account without a subsidiary ledger. However, credit unions that do
substantial investment activity or have a substantial portion of their
assets in investments should maintain adequate subsidiary ledgers.
Page 12-17
EXAMINER'S GUIDE
The subsidiary ledger contains all transactions involving that security.

The credit union should record the following information on each
subsidiary investment record, as applicable:
Name, type, and CUSIP identification;

Par value and any premiwddiscounts (purchase price);
Date of issue;
Date of maturity and call dates;
Date of purchase and sale;
Book value;
Interest or coupon rate, and floating-rate formula and index;
Timing of interest rate adjustments;
Interest rate caps and floors;
Coupon or registered status;
Interest payment dates;
Current fair value (as of each month-end);
Location or safekeeping custodian;
Amortization of premiums or accretion of discount, if applicable;
Current par value (CPV) of pass-through type investments;
Name of broker, if used for purchase; and
SFAS 115 classification.
The credit union should also retain and have available for verification
the original investment confirmations. The examiner should determine
that the credit union maintains current, in balance subsidiary ledgers
that provide sufficient information for managing the investment
portfolios.
Investment Quotes on securities may show both a bid and an ask quote. To
Val uation determine a security's fair value, examiners should apply the bid quote
to the current par value or face value of the security. After determining
the fair value, examiners use the book value to compute market
appreciation or depreciation.
Example: A credit union owns a U.S. Treasury Bond with a face value of
$1,000,000 and a book value of $898,000. The bid is 91.125. Therefore, the fair
value of the security is $91 1,250 ($1,000,000 x .91125.) The market
appreciation or depreciation is: $91 1,250 fair value minus $898,000 book value
equals $1 3,250 appreciation.
Page 12-18
INVESTMENT ANALYSIS
In determining the fair value of the investment portfolio, examiners

may use data supplied by the institution, if available, as of the
examination’s effective date. The examiner should determine that the
credit union uses the same pricing service consistently from period to
period to prevent management from choosing the most favorable
valuation at the end of each period. Examiners should refer to SFAS
1 15, and to the Mutual Funds, Common Trusts, Unit Trusts and
Investment Trading sections, respectively, for specific guidance.
Footnotes to the credit union’s balance sheet should separately disclose
differences between the total fair value and book value of the held-to-
maturity and available-for-sale investments.
If examiners doubt the accuracy of the data, they should test it to

determine the accuracy of the stated fair value and book value. This
may include reviewing the broker-dealer’s market valuation data,
examining the business section of a newspaper, or seeking a third-
party review (e.g., corporate credit union, Office of Strategic Program
Support and Planning, RCMS, etc.) Material miscalculations or
inaccurate disclosures of the fair value of the investment portfolio
resulting from weak internal controls will require appropriate
correction.
Examiners may complete the Amortizing Investments Review and

Certificate Review workpapers in A I M S to assist in the valuation and
trend analysis of investments. Examiners must consult their
supervisory examiners before requesting the credit union to obtain a
third-party review.
Bond Basics A security called a bond represents a debt obligation of the issuer. The
issuer will pay principal and interest to the investor according to the
terms of the bond. A Treasury note is a U.S. Government debt
obligation with an original maturity of 10 years or less. A Treasury
bond has an original maturity greater than 10 years. Debt obligations
of the issuer generally refer to note and bond obligations. Credit
unions often use the terms “notes” and “bonds” interchangeably
when discussing investments.
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EXAMINER’S GUIDE
Principal The issuer must pay to the investor the principal of a bond, also called
the par or face amount. Bonds may have the following characteristics:
Due at maturity or amortizing. A bullet bond has the entire amount

of the principal due at maturity. An amortizing bond has
periodically scheduled principal repayments.
Straight or callable. The issuer of an option free bond (with respect

to principal repayments) must pay the principal amount on the
scheduled due dates. Conversely, the issuer of a callable bond has
the right to accelerate repayment of principal. A callable bond
typically refers to a bond callable in total; however, a mortgage-
backed security (MBS) typically is callable in part (in addition to
the scheduled amortization of principal.) The term “prepayments”
refers to partial calls on an MBS.
MBS and CMO factors. Amortization or prepayments reduce the

original principal amount of a mortgage-backed security or
collateralized mortgage obligation over time. Computing the
outstanding face or outstanding principal balance requires use of
the portion of the original principal outstanding, shown as a factor
in decimal form. For example, a $250,000 original face MBS with
a factor of 0.80000000 has a $200,000 outstanding principal
balance ($250,000 x 0.80000000.)
Coupon Rate The borrower periodically pays the coupon rate or the stated rate of
interest on a bond. The bond may have the following interest rate
characteristics:
Coupon or zero coupon. Zero coupon bonds, sold at a discount

from the par amount due at maturity, do not pay interest
periodically. The discount represents future interest earned over the
term of the investment.
Fixed or floating rate. A fixed-rate bond has a coupon determined

by the interest rate at the time of issuance. A floating-rate bond has
an interest rate index (to which a fixed margin typically is added)
that will reset the interest rate periodically according to the terms
Page 12-20
INVESTMENT ANALYSIS
of the bond. The formula for a floating rate bond should specify the
interest rate index and any margin.
Unrestricted or capped floating rate. An unrestricted floating rate

note (bond) has no restriction on the upper limit in the resetting of
the interest rate. However, a floating rate note may state a
maximum rate of interest, termed a cap (also called a life cap or
ceiling.)
Day Count Calculating a coupon payment amount from a coupon rate requires
Basis knowledge of the day count basis of a bond. The day count basis
defines the method of counting the days in a month and in a year for
the coupon period. The notation to express a day count basis is (days
in month)/(days in year.) Following are the four fundamental day
counts used for domestic investments:
ActuaYActual. The number of days in a month (numerator) is the

actual number. The number of days in the year (denominator) also
is the actual number. Treasury notes use this basis;
30/360. The number of days in each month is counted as 30 days,

therefore, each year has 360 days (12 x 30.) MBS, many CMOS,
and some agency and municipal bonds use this method;
Actua1/360. This method counts the actual number of days in a

month, but counts the basis for a year as 360 days. Money market
securities, including Treasury bills, typically use this method; and
Actua1/365. This method counts the actual number of days in a

month, and counts each year to have 365 days. The quoted rate on
a CD may use this computation.
Accrued Accrued interest is the amount of interest that has accrued on a bond
Interest from the prior coupon payment date (or from issuance for most newly
issued securities) to the accounting statement date or settlement date.
Buyers must pay to sellers any accrued interest, or fraction of the
amount payable on the security’s next coupon payment date. The
Page 12-21
EXAMINER'S GUIDE
Securities Industry Association typically uses the following formula t o

compute accrued interest on periodic coupon paying investments:
Accrued Interest = Principal Amount x (Coupon Rate as a decimal/Number

of Coupon Periods per Year) x (Number of Accrued Days according to the
day count basis from beginning of period to settlement daternumber of
Davs in Interest or Cowon Period.)
Price The secondary market (after issuance) typically quotes bonds on a

Quotations dollar price basis. Quotes for Treasury securities typically reflect a
yield basis at the auction.
Dollar price per $100 par. Bond quotes typically reflect a dollar
price per $100 of principal, without accrued interest. A "clean
price" does not include accrued interest. For example, a $250,000
Agency note quoted at a price of 102 would cost $255,000
($250,000 x 102/100) plus accrued interest. However, a $250,000
original face MBS at a price of 102 with a factor of 0.80000000
would cost $204,000 ($250,000 x 0.80000000 = $200,000
remaining face; $200,000 x 102/100 = $204,000 cost) plus accrued
interest. Coupon bearing securities typically do not use the dirty
price quotes (equal to the clean price plus accrued interest.)
Discount or premium. A bond quoted at a price of less than 100

reflects a discount to par, while a bond quoted at a price of greater
than 100 reflects a premium.
Quotations in fractions. Some publications and broker-dealers may

quote the prices of fixed-income securities in whole dollars and in
32ndsof a dollar per $100 dollars par. For example, an offer price of
100-12 makes that security available for purchase at a price of
$100 and 12/32 (that is, $100.375) per $100 dollars par, plus
accrued interest to the settlement date. Occasionally, a quotation
will include a "+" (plus), which is ?4of one 32nd,or 1/641h.The
following table converts 32ndsto decimal form:
Page 12-22
INVESTMENT ANALYSIS
32nd Decimal 32nd Decimal 32nd Decimal 32"d Decimal

1 0.03125 9 0.28125 17 0.53125 25 0.78125
2 0.06250 10 0.31250 18 0.56250 26 0.81250
3 0.09375 11 0.34375 19 0.59375 27 0.84375
4 0.12500 12 0.37500 20 0.62500 28 0.87500
5 0.15625 13 0.40625 21 0.65625 29 0.90625
6 0.18750 14 0.43750 22 0.68750 30 0.93750
7 0.21875 15 0.46875 23 0.71875 31 0.96875
8 0.25000 16 0.50000 24 0.75000 32 1.00000
Yield The yield on an investment is a function of the coupon rate, the

Quotations purchase price, and the term to maturity. Users should take care to
recognize the days basis used for the yield quotation. Common
methods to quote yields include:
Bond-equivalent yield (BEY.) The Securities Industry Association

calls this semi-annual compounding yield the universally
comparable yield. Quotes for the yield on a security with a term to
maturity of greater than one year typically reflect a bond-
equivalent basis. BEY is the industry standard for quoting yield.
Annual percentage yield (APY.) Annual compounding forms the

basis for computing APY. Credit unions must disclose this yield to
members, but the institutional fixed-income investment market
does not use it.
Money market (or discount) yield. Calculating this simple interest

return on an investment uses price as the basis (also used for
investments with a maturity of less than one year.)
Discount rate. Calculating this simple interest rate of return on an

investment uses redemption value (e.g., the face amount of a
Treasury bill due at maturity) as the basis (also used for
investments with a maturity of less than one year.)
Investment §107(7)(B) of the FCUAct authorizes a federal credit union to invest

Products in the obligations of the United States of America, or in securities fully
guaranteed as to principal and interest.
Page 12-23
EXAMINER’S GUIDE
US Treasury U. S. Treasury securities, which are fully guaranteed obligations of the

Securities United States government, include bills, notes and bonds currently
issued only as book-entry securities in the Federal Reserve book-entry
system. Credit unions may purchase Treasury securities directly at
Federal Reserve auctions through either a competitive or a
noncompetitive bid. They may submit competitive bids on a yield
basis for a specified amount of Treasury securities. Treasury accepts
the bidders with the lowest yields (i.e., highest prices for the Treasury
securities.) The Federal Reserve awards Treasury securities purchased
by a noncompetitive bid, generally for up to $5 million face amount, at
a price equal to the average of the competitive bids accepted by the
Treasury.
Credit unions may also purchase Treasury securities in the secondary

market from a securities dealer or financial institution. Purchasing
Treasury securities does not require a primary dealer. Large volumes
and narrow bid-ask spreads characterize the highly liquid Treasury
securities’ secondary market.
A safekeeping receipt typically evidences a credit union’s Treasury

securities. Alternatively, a statement of holdings from the Federal
Reserve evidences ownership of Treasury securities held directly by
the credit union in the book-entry system.
Treasury Bills Treasury bills issued by Treasury consist of discount securities

auctioned and quoted on a discount rate basis, with an original
maturity of 91 days, 182 days, or 52 weeks. Occasionally, Treasury
will issue special maturity Treasury bills in the form of cash
management or tax anticipation bills. Treasury bills have a face value
that reflects the return of a single cash flow (also called a redemption
amount) to the investor at maturity. The dollar discount, calculated by
multiplying the discount rate (as a decimal) times the face value times
the number of days remaining to maturity divided by 360 days (the
days basis), represents the difference between the purchase price and
the face value (i-e., the amount of interest the investor receives at
maturity.) The dollar purchase price reflects the difference between the
face value and the dollar discount.
Page 12-24
INVESTMENT ANALYSIS
Comparing the Treasury bill interest rate to a coupon security (e.g., a

Treasury note) requires calculation of the Treasury bill’s bond-
equivalent yield (BEY), a universally comparable semi-annual yield
(i.e., a nominal annual yield assuming semi-annual compounding.)
Credit unions cannot compare in a meaningful way the discount rate to
the BEY on a Treasury note or bond. The discount rate, based on the
face value of the investment rather than the dollar purchase price, uses
a 360-day, rather than a 365-day basis for its calculation. Alternatively,
calculation of the money market yield facilitates comparison of the
interest rate on a Treasury bill to another money market instrument.
Treasury Treasury notes and bonds represent coupon-bearing securities. The

Notes and U S . Treasury auctions Treasury notes on a BEY basis and quotes
Bonds them on a price basis in the secondary market. Treasury notes and
bonds pay interest semi-annually and return the principal amount (face
value) to the investor at maturity. The U.S. Treasury issues Treasury
notes with an original maturity of 2,5, or 10 years and Treasury bonds
with an original maturity of 30 years. Occasionally, Treasury will
reopen a previously issued security and auction additional amounts.
Treasury 5703.1 1O(d) prohibits the purchase of a zero coupon investment with a
Zeros or maturity date more than 10 years from the settlement date, unless the
STRIPS credit union is exempt under the Reg Flex provisions of Part 742.
Treasury prices a zero-coupon or “ stripped” security at a discount to
face value before maturity. A “corpus strip” reflects a claim to the
principal portion of a Treasury security, as contrasted with a stripped
coupon’s claim to an interest payment.
STRIPS (Separate Trading of Registered Interest and Principal of

Securities) is the U.S. Treasury program that permits separate trading
and ownership of the interest and principal payments on 10-year and
longer term original maturity Treasury notes and bonds maintained in
the book-entry system operated by the Federal Reserve Banks.
STRIPS reflect direct obligations ofthe U.S. Government.
For example, a 10-year, 6 percent coupon, $1,000,000 Treasury note

may be separated into 20 different coupon STRIPS (one for each of 20
semi-annual payments of about $30.,000each) and one corpus STRIPS
Page 12-25
EXAMINER’S GUIDE
(the $1,000,000 principal due at maturity.) STRIPS also can be

reconstituted into the original Treasury note or bond.
Other US In addition to Treasury securities, the U.S. Government fully

Guaranteed guarantees the principal and interest of certain other securities, such as
Securities Government National Mortgage Association (GNMA or Ginnie Mae)
securities and Government of Israel notes.
Federal In the bond market, the term “federal agency securities” generally
Agency applies to two different types of securities: (1) a security issued by a
Securities Government corporation (wholly or partially owned by the
Government), usually with an unconditional guarantee of the U.S.
Government; and (2) a security issued by a government sponsored
enterprise (GSE), often explicitly guaranteed only by the issuer.
Permissible investments for federal credit unions include the

obligations, participations or other instruments issued by federal
agencies as authorized in 0 107(7)(E) of the FCU Act, wholly-owned
Government corporations designated in 9 10 1 of the Government
Corporation Control Act (31 U.S.C. $9101(3)),and other securities as
authorized in 0107(7)(E) and 0107(7)(F) of the FC‘U Act. Most wholly
owned Government corporations no longer issue their own securities.
Government The Federal Financing Corporation generally provides funds to

Corporations Government corporations and borrows those funds from the
Department of the Treasury that, in turn, issues Treasury securities.
Recently issued securities of Government National Mortgage
Association, Small Business Administration, and Tennessee Valley
Authority commonly fall within this category.
Wholly owned Government corporations include:
0 Government National Mortgage Association (GNMA or Ginnie

Mae); and
0 Tennessee Valley Authority (TVA.) The full faith and credit of the
US government do @ back these Tennessee Valley Authority
securities.
Page 12-26
INVESTMENT ANALYSIS
Entities formed to assist with problems in the savings and loan

industry include:
Financing Corporation (FICO);

0 Resolution Trust Corporation (RTC); and
0 Resolution Finance Corporation (RefCorp.)
These mixed-ownership Government corporations have issued,

directly or indirectly, certain securities in which federal credit unions
may invest including certain mortgage-backed or mortgage-
collateralized securities.
Government Government Sponsored Enterprises (GSEs) are privately owned,

Sponsored Congressionally chartered corporations. The government establishes a
Enterprises GSE to provide funding to a sector of the economy otherwise
underserved by purely private financial intermediaries. Because GSEs
play an important role in sectors of the economy, GSEs are
instrumentalities of the U S . Government for specific purposes. SEC
registration requirements exempt GSE debt obligations. However,
GSEs do not carry an explicit guarantee of the U.S. Government.
GSEs that issue securities include:
Federal National Mortgage Association (FNMA or Fannie Mae);

Federal Home Loan Mortgage Corporation (FHLMC or Freddie
Mac);
Farm Credit System (including Federal Farm Credit Bank (FFCB)
and Farm Credit System Financial Assistance Corporation
(FACO));
Federal Home Loan Bank System (FHLB);
Federal Agricultural Mortgage Corporation (FAMC or Farmer
Mac); and
Student Loan Marketing Association (SLMA or Sallie Mae.)
SLMA formed a holding company for the purpose of giving up its
GSE status. Securities issued by SLMA with final maturities not to
extend beyond September 30, 2008 remain permissible
investments for federal credit unions. However, federal credit
unions may not invest in securities issued by SLM Holding
Corporation.
Page 12-27
EXAMINER'S GUIDE
Permissible Investments for Federal Credit Unions
Issuer or Security Backed by US Permissible for Federal Natural

Originator Government Person Credit Union -
Provision of FCU Act (or other
- law)
FNMA (Fannie NO YES - 107(7)(E)
Mae)
FHLMC NO YES - 107(7)(E)
(Freddie Mac)
FFCB (Farm NO YES - 107(7)(E)
Credit)
FACO YES YES - 107(7)(B)
FHLB NO YES - 107(7)(E)
FAMC (Farmer NO YES - 107(7)(E) (and 12
Mac) U.S.C. 2279aa-l2(c))
SLMA (Sallie NO YES - 107(7)(E)
Mae)
FICO NO (principal backed by zero- YES - 107(7)(E) (and 12
coupon Treasuries) U.S.C. 1441(e)(6))
RTC NO Certain trusts are permissible
mortgage-related security
investments
RefCorp NO YES - other agency 107(7)(E)
Obligations Agency obligations include short-term notes, long-term debenture

bonds, and structured notes, described as follows:
Short-term notes - generally discount securities (similar to

Treasury bills) with a single cash flow at maturity;
Debenture bonds - also called consolidated bonds when issued by
Farm Credit generally pay interest semi-annually
0 Structured notes - typically contain call provisions or other
embedded derivatives; credit unions that do not understand the
risks of the embedded derivatives should not invest in these
securities.
Participations Participations differ from debenture bonds in that specific assets,

typically mortgage loans, back participation bonds. Generally, the U.S.
Government (for Ginnie Mae) or a GSE (for Famie Mae and Freddie
Mac) guarantee these securities.
Page 12-28
INVESTMENT ANALYSIS
One loan or a pool of loans may back participation certificates. To

reduce prepayment risk on securities purchased at a premium,
management should know the approximate number of loans in the
participation pool and, if geographic diversification warrants, their
location. For the more recent issues, the Bloomberg screens, offering
circulars, or other external means provide characteristics of the
participation pools.
Management should thoroughly analyze the risk of uncertain cash

flows associated with mortgage pass-through certificates. As market
interest rates rise, prepayments generally slow down. As rates move up
and the repricing of investment cash flow diminishes, members
increase pressure for higher dividend rates. Likewise, prepayments
generally increase as rates move downward. If rates decrease, the
credit union must then reinvest excess dollars at lower rates, further
reducing asset yields. As such, standard prepayment models (e.g.,
those available through Bloomberg) often help project cash flow for
mortgage pass-through securities. (For further guidance on standard
prepayment models, refer to the section on CMOS in the Investment
Guidance Papers located in the NCUA E-Library.)
Participation certificates may also consist of variable- or fixed-rate

loans. From an asset-liability standpoint, management should know the
correlation between the variable rate formula (e.g., the index plus the
margin) used to determine the loans' interest rate and the credit
union's cost of funds.
Usually, the participation certificate holder receives monthly payments

of principal and interest directly from the servicer of the loan who, in
turn, received those payments from the borrower, resulting in a "pass-
through" security. A "modified pass-through" means that the agency
guaranteeing the security ensures the timely payment of principal and
interest. Following is Illustration 12-A, a secondary market flowchart
for modified pass-through securities.
Basic securities are of two types:
Pass-Throughs. Investors share in cash flow from the underlying

mortgages on a "pro-rata" basis. Monthly payments and
Page 12-29
EXAMINER'S GUIDE
prepayments of principal and interest are divided among the

investors according to the relative size of their investment.
Secondary Market Flow Chart
#1 Individual wants $l00,OOO to purchase or refinance a principal residence

and usually requests a long-term fixed rate (high level of IRR.)
#2 Credit union wants to loan money, charge points and fees, and "service" the
debt. If the credit union does not wish to assume the reduced liquidity or increased
IRR associated with mortgage lending, it structures the loan to qualify for the
secondary market. The credit union then has the option of selling the loan
immediately or at a later date, thus enabling it to make additional loans.
#3 Intermediary (e.g., GNMA, FHLMC, and FHA) established to provide a

ready source of housing funds. These agencies set secondary market standards
based on historical records to ensure high quality loan underwriting and
documentation, which allow the agency to "guarantee" loan principal and interest
payments. The intermediary issues to individual investors certificates or securities
collateralized (in whole or in part) by the mortgages purchased from the credit
union.
#4 Individual investors willing to buy a security collateralized by the

mortgages. They receive a guarantee of monthly principal and interest payments
and a higher yield than they would receive if they invested in a Treasury security
with a similar maturity. The investors, in turn, assume interest rate and prepayment
risks resulting from uncertainty as to the repayment period of the principal and
interest from the collateralized mortgages in the pool. For example, if individual
homeowners refinance or move, they pay off the entire loan early rather than over
their original mortgage periods (usually 15 or 30 years.)
Illustration 12-A
0 CMO/REMIC. Investors share in cash flows on a "prioritized"

basis by purchasing into a "tranche" or class. The prospectus
provides details of when the investor will receive interest,
principal, andor prepayments.
Secondary Secondary participations usually do not have a timely payment

PafiiciPations guarantee. Insured student loans (other than those primarily guaranteed
Page 12-30
INVESTMENT ANALYSIS
by a state or private agency), Farmers Home Administration (FmHA)

Business and Industrial Loans, and the guaranteed portion of loans
guaranteed by the SBA fall into this category.
Credit unions holding secondary participations should file all

appropriate forms with the insuring agency and retain written
assurance that the secondary participation loans meet all requirements
in the event that the borrower defaults and the credit union must file a
claim. Officials should understand the credit union's collection
responsibilities under the insuring clauses that support the investments
in question.
The credit union should ensure that participation certificates and other
secondary participations meet the requirements of 0107(7)(E) or
9 107(7)(F) of the FCUAct, and that no obstructions exist that might
invalidate the federal guarantee.
GNMAs A pool of mortgages insured or guaranteed by the Federal Housing

Administration (FHA), the FmHA, or the Veterans Administration
(VA) backs a GNMA. GNMA guarantees the timely payment of
principal and interest to the security holders. The credit union normally
receives payment on the fifteenth of each month for GNMA I, or on
the twentieth for GNMA 11. This payment includes the scheduled
principal payment, any prepayment of principal on the security, and
coupon interest for the prior month.
Because GNMAs have the principal repayment feature, the credit

union must know the pool factor to compute the principal outstanding.
The Bond Market Association publishes a schedule for the factors
(Prepayment Announcements.) For example, GNMA I factors are
announced about the fifth business day of the month, and GNMA I1
factors a business day later.
The factor for a GNMA represents the amount of principal that

remains outstanding as of the end of the previous month. When
reconciling safekeeping statements, examiners should note that
statements may show the factor for the current month, and report only
the payment amounts for principal and interest from the previous
month, not those scheduled for receipt in the current month.
Page 12-31
EXAMINER’S GUIDE
Settlement on GNMA trades occurs once each month, according to a

schedule published by The Bond Market Association. For example,
most 30-year GNMA I securities have a settlement date of about the
sixteenth business day of the month. To settle on the current month’s
settlement date, the credit union must make and report a transaction on
or before the notice date, which is 48 hours before the settlement date.
A GNMA’s principal balance as of the end of the previous month

provides the basis for the settlement amount. Thus, while a transaction
sets the dollar price per $100 of outstanding principal, the credit union
cannot compute the actual dollar amount due at settlement until it
knows the pool factor for computing the outstanding principal.
A credit union should accurately record principal repayments and

interest payments. Staff should properly reflect the security’s
outstanding balance by reviewing the statements received from either
the servicer of the GNMA pool or the credit union’s broker.
GNMA issues GNMA securities in book-entry form in the electronic

book entry system of the Mortgage-Backed Security Division of the
Depository Trust Company (DTC.)’
Each month, credit unions registered as owners of GNMAs receive an

Issuers Monthly Remittance Advice. This form usually accompanies
the monthly payment and identifies the amount of principal repayment,
interest income, and the outstanding balance of the security. The
examiner may verify these figures with those on the credit union’s
books.
Most credit unions hold GNMA securities through a custodian that

maintains a chain of custody through a participant in DTC. The credit
union receives a statement from its custodian. Information contained
on these statements may vary slightly from custodian to custodian.
Examiners and credit union staff can verify the principal repayment,
interest income, and the security’s current par value from the
custodian’s statements against the figures in the credit union’s books.
Since December 1 1, I 990, investors holding older physical-form GNMA securities

may convert them to book-entry form, with the exception of GNMA Serial Notes.
Since December 1986, non-eligible securities and book-entry eligible securities that
were not delivered according to good delivery guidelines remain in physical form.
Page 12-32
INVESTMENT ANALYSIS
If a custodian's statement does not provide the current par value of the
security, the examiner may compute the balance as follows:
Obtain the original par value of the security fi-om the trade sheet (if
available) or fiom the subsidiary ledgers;
0 Obtain the GNMA pool factor. (The pool factor represents the
percentage of principal still outstanding.);
0 Multiply the original par value by the factor to determine the

current par value (remaining principal balance); and
0 Verify the computed value against the figures in the credit union's
records.
Example: A credit union purchased a GNMA modified pass-through security

with an original par value of $1,007,008.33. The GNMA pool factor is
.99703096.
Original par value $1,007,008.33

GNMA pool factor .99703096
Current par value (CPV) $1,004,018.48
To determine reasonableness of the fair value of a recently issued

GNMA, the examiner may look up the bid price for the stated interest
rate and multiply the bid price by the outstanding principal balance of
the investment to determine the fair value. A published bid price for a
recently issued GNMA typically will not reflect fair value for a
seasoned GNMA, that is, for a GNMA security with a shorter
remaining maturity. (See the Mortgage Valuation workbook in AIRES
for indication values for mortgage related securities.)
SBA Fixed-rate Small Business Association (SBA) guaranteed loans have

Guaranteed appealed to some credit unions because of their relatively high yields.
Loans SBA also has a variable-rate participation loan, in which the loan rate
generally adjusts quarterly and moves with the prime rate, thus
reducing the IRR of the security.
However, the lack of an active secondary market for these loans limits
their marketability, making them more suitable as a long-term
Page 12-33
EXAMINER'S GUIDE
investment than as a liquid asset. Generally, SBA single loans contain

more risk than SBA loan pools. Likewise, SBA loan pools that have a
small number of loans carry more risk than do pools with larger
numbers of SBA loans. In other words, the larger the number of loans
in the pool, the more predictable is the pool's performance and the
better its marketability.
SBA loans, whether fixed or variable rate, do not have a consistent

average life and SBA can call them for immediate repayment, which
could result in a loss if the credit union purchased the SBA at a
premium. In addition, the "thin market" (i.e., not an actively traded
secondary market and a limited number of brokers making a primary
market in SBAs) restricts marketability of these instruments.
Example: A credit union purchased a $100,000, 10 percent, 5-year SBA loan at

105. After one year, the balance of the loan was $80,000 and the unamortized
premium was $4,000. The borrower repaid the loan in full at this point. Since
SBA guarantees repayment only at par, SBA would not reimburse the credit
union for the remaining $4,000 unamortized premium and the credit union must
absorb the loss during the current accounting period.
Credit unions should be aware of the dangers of purchasing SBA loans

and other secondary participations at high premiums. However, the
decision of whether or not to purchase SBAs remains with the
officials.
Zero Coupon As with Treasury securities, which can be stripped into zero coupon
Bonds securities, agencies (e.g., TVA) and other financial institutions can
offer zero coupon debt obligations.
The price of a zero coupon security exhibits more sensitivity to

changes in interest rates than does the price of a similar maturity
coupon bearing bond. In fact, prices of longer-term, zero coupon
securities can react strongly to changes in interest rates. This price
volatility can attract credit unions wishing to speculate in trading of
zero coupon securities. As such, a credit union's investment in a zero
coupon security may be legal, but not appropriate from an asset-
liability standpoint.
A federal credit union may not purchase a zero coupon investment

with a remaining maturity greater than I0 years from the settlement
Page 12-34
INVESTMENT ANALYSIS
date. A credit union may “grandfather” a zero coupon bond purchased

before December 2, 1991, unless it poses a safety and soundness
concern. If examiners determine that the investment poses a significant
threat to the continued sound operation of the credit union, they should
contact their supervisory examiner before further assessing the
situation.
Examiners should determine that the credit union properly records the
zero coupon securities. Management determines the present value of
the single cash flow using the purchase interest rate, typically a bond-
equivalent yield. Accounting for these securities requires accreting the
discount using the interest method (also termed scientific or level
yield.) Unlike the straight-line method, the interest method results in a
lesser amount of income earned in early periods than in later periods.
Examiners should also ascertain whether the credit union purchased

these securities for trading purposes. If the credit union trades these
securities, the examiner should consult the supervisory examiner. The
examiner should review the credit union’s trading policies, operating
procedures, and level of overall risk in the investment portfolio (also
see the Investment Trading section.)
SMBS Stripped mortgage backed securities (SMBS) or SPLITS, more

10s and POs commonly referred to as interest only securities (10s) and principal
only securities (POs), resemble zero coupon type instruments.
However, they possess the additional characteristic of uncertain cash
flow and the resulting uncertain returns. The issuer strips the principal
and interest payments from the underlying mortgage-backed securities
and SPLITS them into separate investments. Investors in a PO receive
a pro rata portion of the principal payments on the underlying
mortgages, while investors in an I 0 receive a pro rata portion of the
interest payments on the underlying mortgages.
$703.11O(c) prohibits the purchase of stripped mortgage backed

securities (SMBS), residual interests in collateralized mortgage
obligations (CMOS) and real estate mortgage investment conduits
Page 12-35
EXAMINER’S GUIDE
(REMICs), and mortgage servicing rights. Purchase of SMBS solely

for reducing IRR is no longer permitted for new purchases.’
NCUA grandfathered investments in SMBS acquired before January 1,

1998, unless they posed a safety and soundness concern (see 5703.130
for further guidance.) Credit unions holding grandfathered, stripped
mortgage-backed securities to reduce IRR in accordance with NCUA’s
Rules and Regulations must report the security as a trading asset at fair
value through income or as an available-for-sale asset at fair value
through equity until its disposition.
Credit unions that purchased SMBS before December 2, 1991, should:
Carry them at amortized cost if the credit union has both the intent
and the ability to hold the SMBS to maturity. Amortized cost is
original cost (present value of future cash flows) systematically
adjusted to the amount that the credit union expects to realize
through the maturity date;
Use the interest method of amortization or accretion to record
interest income over the life of the investment unless the straight-
line method results in a materially equivalent amount;
Retain a copy of the prospectus; and
Provide reports and analysis documenting the reduction in risk at
the time of purchase (since credit unions may only hold SMBS to
reduce IRR) and periodically thereafter.
As with all mortgage-backed securities, credit unions may need to

periodically adjust the carrying value of the SMBS through current
period income to reflect significant changes in the prepayment rates of
the underlying pool of mortgages. Effective yield calculations reflect a
security’s purchase price relative to expected future periodic cash
flows, anticipating estimated mortgage pay-down speeds over the life
of the security.
As the underlying mortgages pay down significantly faster or slower

than originally anticipated, the carrying value of the SMBS may
require adjusting. This adjustment involves recalculating the effective
yield used in the amortization to reflect an effective yield based on
Before January 1, 1998 but after December I , 1991 NCUA’s Rules and
~
Regulations permitted credit unions to purchase SMBS solely for reducing IRR.
INVESTMENT ANALYSIS
actual payments to date and anticipated future payments. As a result of

the adjustment, the net investment in the loans reflects the amount that
would have existed had application of the "revised" effective yield
occurred since the acquisition of the loans. The adjustment to the new
balance involves debiting or crediting the investment in loans with a
corresponding charge or credit to interest income.
When reviewing SMBS, examiners should do the following:
0 Determine that the officials understand the risk associated with

SMBS (especially 10s) as outlined in the prospectus;
0 Review for reasonableness the accounting treatment and its basis.
CMOs Collateralized mortgage obligations (CMOs) are multi-class pass-

through bonds; either general obligations of the issuer backed by
mortgage collateral or limited obligations where the bondholders rely
on the pledged collateral for payment. Each bond class, or tranche, has
a stated maturity date and a fixed coupon or variable rate. The cash
flows generated by the collateral relate to the cash flows of the bonds.
After making interest payments, all available cash goes to repay
principal on the "fastest" pay tranches. Principal payments go to one or
more classes at a time, based on an order of priority determined at the
bond issue date. Illustration 12-B shows a CMO where principal
payments go to one class at a time.
In a simple sequential pay structure, following retirement of the first

class, the next tranche in the sequence becomes the exclusive recipient
of principal payments until its retirement. In more complex structures,
the first class may be some form of "support tranche," created to
protect the planned amortization classes (PACs) and target
amortization classes (TACs) of the total offering. The support tranche
will absorb any unanticipated cash flows with a paydown in principal,
and will extend their maturities when prepayment speeds diminish.
The potential for increased certainty of cash flow patterns, faster return
of principal over the mortgage pass-through type securities, and
attractive yields have made CMOs popular investments. If their
structure sufficiently protects them from prepayment and extension
risk, CMOs can appropriately enhance yield for a credit union that
Page 12-37
INVESTMENT ANALYSIS
thoroughly understands the product. However, a credit union must

closely analyze a CMOs’ characteristics before investing.
5 107(7)(E) and 0 107(15) of the FCU Act authorize credit unions to

invest in collateralized mortgage obligations (CMOs) issued by
FHLMC, FNMA, and GNMA, and permissible private issuers. CMOs
issued by FHLMC or FNMA carry little or no credit risk. Groups that
offer privately issued CMOs include securities firms, savings and
loans, mortgage bankers, home builders, and life insurance companies.
Most privately issued CMOs are highly rated, however, a credit union
that anticipates buying a privately issued CMO should ensure that the
CMO’s rating falls within one of the two highest categories by at least
one nationally-recognized statistical rating organization.
CMOs can contain significant liquidity and IRR including the

following:
0 Unanticipated principal prepayments on the collateral could result

in the issuer retiring the bonds substantially earlier than their final
maturity date;
0 In a declining interest rate environment, credit unions that reinvest
excess dollars at lower rates usually experience reduced yields;
0 If the credit union purchased the instrument at a premium, the
effective rate of return decreases as prepayments increase in a
declining rate environment; and
As interest rates move upward, cash flow could decrease
significantly and reduce the amount of funds available to reprice at
the higher rates.
Complex CMO investment instruments require that credit union

investors understand the potential cash flows and related yields. For
example, a CMO issue may include numerous tranches ranging from
PACs (I, 11, and 111) to TACs to very accurately defined maturities
(VADMs) to Z-Bonds to companion or other support classes.
Furthermore, the average life and final maturity of a CMO depends
upon the payment priority of the CMO within the issue’s deal
structure, and often creates interdependencies with other classes within
the same CMO issue. Examples of typical classes within a CMO issue
and related risks include:
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EXAMINER'S GUIDE
Planned amortization class (PAC.) Generally, the PAC class of a

typical CMO contains less risk and has a well-defined tranche that
receives priority over other classes within the issue. While PAC
CMOS exhibit less uncertainty in cash flow pattern, the certainty of
its cash flow depends on a "range" (or "band" or "collar") of
prepayment speeds. However, cash flow patterns could
significantly change if the speed of the issue moves outside the
PAC range.
A CMO issue may include one or more PACs, often referred to as

PAC I, PAC 11, or even PAC 111. The first PAC may have a wider
PAC band or level of protection than other PACs within the CMO
issue, thus covering a wider range of prepayment speeds.
0 Very accurately defined maturity (VADM.) The VADM class

may contain the least risk of the various classes. VADMs tend to
have relatively short stated final maturities, and typically have
PAC bands covering upwards from "0" percent prepayment speed
assumptions (PSA.) The higher the PSA, the shorter the time in
which the credit union anticipates the return of its principal dollars.
For example, a "0" PSA means no anticipated prepayments within
the mortgage pool (an unlikely event.) A PSA of 100 means a
repayment rate of 6 percent per year. A PSA of 200 means a
repayment rate of 12 percent per year.
When interest rates rise, members generally repay their mortgages

at a slower rate causing PSA rates to fall. The reverse is true in a
declining interest rate environment. From a cash flow standpoint,
the VADM may have a relatively short repayment window. Thus,
the wide "bandttcoverage of a VADM, combined with the short
and relatively stable stated maturities, makes this class a low risk
category in contrast to others.
0 Targeted amortization class (TAC.) The market typically refers

to TACs as "half PACs". They are slightly more volatile than
PACs or VADMs, but more stable than a Z-Bond or other support
classes. TACs offer some protection against prepayment risk
(falling interest rate environment), but not against extension risk
(rising interest rate market.)
Page 12-40
INVESTMENT ANALYSIS
Companion or support class. The companion or support classes,

one of the more volatile classes within a CMO issue, receive
principal payments only if other, higher priority classes (e.g.,
PACs, TAC, etc.) have received their scheduled payments. This
may require the issuer to redirect cash flows within the pool to
other higher priorities. As a result, the predictability of cash flow
patterns often remains highly uncertain. A credit union investing in
companion or support classes must fully understand the complexity
of the CMO issue, the interrelationships within the CMO, and their
likely effect on future cash flow projections.
0 Z-Bonds. An accrual bond or Z-bond tranche does not receive any

cash payments of principal or interest before retirement of all
tranches preceding it. Many CMO issues include one or more
accrual bond tranches. In effect, an accrual bond is a deferred
interest obligation with a varying payment date, resembling a zero
coupon bond before the retirement of the preceding tranches. With
its long average life, the Z-Bond often has high price sensitivity to
changes in interest rates. The Z-Bond tranche receives repayments
last, which makes it one of the riskiest of the various classes.
REMIC Generally, a real estate mortgage investment conduit (REMIC) is the

tax-preferred method of issuing CMOs. To qualify as a REMIC, the
interests in the REMIC fall within one or more classes of "regular"
interests and a single class of "residual" interest. Regular interests are
the classes of a CMO issue. The residual interest consists of the excess
interest and reinvestment earnings that exist as a result of the
differential between the income flow from the underlying mortgages
and the income outflow to the regular interest holders.
IRPS 98-02 Examiners should ensure that credit union officials understand the
sound principles and practices provided by IRPS-98-02, which
recommends that credit unions having material positions in complex
securities such as CMOs perform reasonable analysis both at time of
purchase and periodically thereafter. After October 1, 1998, credit
unions need not obtain the FFIEC high-risk securities test (HRST) for
CMOs and real estate mortgage investment conduits (REMICs) in
natural person credit unions.
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EXAMINER'S GUIDE
IRPS 98-02 recommends analyses similar to that which underlies the

HRST for credit unions having material positions in complex
securities. The following three tests serve as a benchmark for a federal
credit union's analysis:
0 The average life sensitivity test - tests the average life of the
security, assuming an immediate shift in the yield curve of plus
300 basis points, and a decline on the downside (-300 basis points);
0 The average life test - reviews the CMO's expected average life for
base case exposure; and
0 The price sensitivity test - tests the estimated change in the CMO's
price due to an immediate and sustained parallel shift in the yield
curve of plus or minus 300 basis points.
Assumptions for the analysis include market interest rates and

prepayment speeds at the time of valuation, thus enabling the credit
union to comply with the IRPS 98-02 requirement that it knows the
value and price sensitivity of its investments. The credit union must
maintain, and have available for examiner review, documentation
supporting the analysis ($703.40.)
At a minimum, the credit union should obtain a prospectus (when

available) and closely analyze the characteristics of the CMO issue
using standard industry calculators (e.g., Bloomberg, etc.) before
purchasing the security. Projecting future cash flows of CMOS under
various interest rate conditions is a complex task; therefore, NCUA
recommends using an acceptable standard prepayment model to
analyze IRR under various prepayment assumptions. NCUA Letter
No. 139 encourages credit unions to obtain prepayment forecasts from
at least three different dealers before purchase.
Am unreasonable PSA can produce inaccurate test results. A broker

could manipulate the prepayment assumptions to make a CMO appear
less risky (see example in the addendum.) Thus, the examiner should
review the "source" of the prepayment assumptions for consistency.
The industry uses a wide variety of "sources" for prepayment
assumptions including Andrew Davidson, CMO Passport, First
Page 12-42
INVESTMENT ANALYSIS
Boston, UBS, DLJ, Paine Weber, JP Morgan, Bear Stearns, and

Median, which is an average of the dealer estimates.
The Investment Guidance Paper for March 1997, Section D, Exhibits

1 to 17, includes an example and description of the HRST and other
important Bloomberg screens. Bloomberg continues to support this
screen as it provides detailed analytics for CMO/REMIC securities.
The "Assumption and Source" area for the test specifies the PSA used
in the analysis.
Examiners should watch for credit unions that rely on a "CUSTOM"

prepayment model source, a customized set of prepayment
assumptions. Unless management can fully support the assumptions
used in a "CUSTOM" prepayment model, examiners should request
additional tests using industry standards. Examiners may readily
accept some "CUSTOM" prepayment models. For example, a
brokerage firm may offer a "CUSTOM" prepayment speed derived
from the median, average, or most conservative estimate from all of
the models available (Bloomberg, etc.)
Stress analysis outcomes, based on inconsistent prepayment

assumptions, can vary from model to model. Credit unions can comply
with the IRPS by analyzing material positions in a CMO or REMIC
using a single model; however, a conservative approach would rely on
at least three different models. The credit union should ensure that the
analysis of securities is reasonably within its limits.
Occasionally a CMO or REMIC could acceptably withstand a 300

basis point change, but present higher risk at some lesser shift in the
yield curve. The credit union should understand the risk for all yield
curve shifts, up to and including a 300 basis point shift. Acceptable
testing at 100,200 and 300 basis point shifts should sufficiently
address these concerns.
Management should also consider the potential for decline in fair

values of the investment portfolio over a variety of interest rate cycles
and the likely effect on net worth. The "price sensitivity" analysis tool
projects the potential effect on a CMO's fair value in various interest
rate cycles.
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EXAMINER’S GUIDE
Officials should demonstrate the CMO’s suitability for the credit union
from an ALM standpoint. While the CMO may be legal, its anticipated
cash flow patterns or potential maturity in relationship to the share
structure may render it unsuitable for the credit union. For example, a
credit union investing a significant portion of its assets in CMO
tranches with long average lives could raise safety and soundness
concerns if its share base is short-term.
The credit union remains responsible for obtaining analysis

information. However, the examiner may need to obtain an analysis
through the Office of Strategic Program Support and Planning or the
regional office under certain conditions:
0 The examiner suspects the reasonableness of the broker’s

assumptions or other variables (e.g., PSA); or
0 The credit union cannot get analysis information and the CMO
could substantially affect the credit union’s financial health.
Examiners should call the Investment Hotline (800-755-5999) or their

RCMS to discuss CMO questions. Examiners may seek the orderly
disposal of any CMO or REMIC if the investment poses a significant
threat to the continued sound operation of the federal credit union
under IRPS 98-02. Before requesting an onsite analysis or
recommending divestiture, the examiner should discuss the credit
union and its circumstances with the supervisory examiner and follow
regional procedures.
Divestiture of Responsibility for assessing balance sheet risk lies with the credit
Securities union officials. If the examiner’s analysis determines the credit union
has a significant position in high-risk securities (e.g., CMOs, REMICs,
or other complex securities that have excessive risk) or inconsistency
with the credit union’s investment, liquidity or asset-liability policies,
the examiner may review management’s analysis and determine
whether the credit union can manage the risk of holding the high-risk
CMOs or complex securities.
Some of the factors for examiners to consider in evaluating whether a

credit union may safely hold high-risk investments include:
Page 12-44
INVESTMENT ANALYSIS
0 Ability of the officials to explain the instrument’s characteristics

and risks to the examiner;
0 Ability of the officials to obtain and adequately evaluate the

instrument’s market pricing, cash flows and test modeling;
0 Ability of the officials to define, explain and document how the

high-risk investments fit into the credit union’s ALM strategy; and
0 The effect that either holding or selling the high-risk bonds will
have on earnings, liquidity and net worth in different interest rate
environments.
After obtaining the concurrence of the supervisory examiner and

regional office, examiners may seek divestiture if they believe
continued ownership of high-risk securities represents an undue risk to
the credit union. This risk can arise from the following:
0 The size of a credit union’s holdings of high-risk securities in

relation to its capital and earnings;
0 Management’s inability to demonstrate an understanding of the
nature of the risks inherent in the securities;
0 The absence of internal monitoring systems and other internal
controls to appropriately measure the market and IRR of these
securities; or
0 Management’s inability to manage its overall IRR.
If the region considers the credit union’s continued holding of the

high-risk securities a safety and soundness concern, both the examiner
and supervisory examiner will meet with the officials to reach
agreement for divesting the securities or developing an acceptable plan
to mitigate the risk. If they cannot reach an agreement with the
officials, the examiner will prepare a preliminary warning letter or
recommend other administrative action, following regional procedures.
Examiners will document the agreements reached in the report. They
also should follow-up with the credit union as necessary to ensure
compliance with the agreements.
Federally insured state-chartered credit unions holding high risk

CMOS or REMICs must record unrealized gains or losses under SFAS
Page 12-45
EXAMINER'S GUIDE
1 1 5 (see 8741.21.9);however, they need not establish a special reserve

for non-conforming investments. Following regional working
agreements with the SSA, examiners will discuss and coordinate
divestiture of high risk CMOSthat present safety and soundness
concerns in state-chartered credit unions with the appropriate state
regulator.
Residual A federal credit union may not purchase a residual interest in a CMO
Interests or REMIC. Management should provide reports and data to the
examiner and the board on how it proposes to reduce IRR.
Fair Values The credit union must determine the fair values of the securities at
least monthly, in accordance with $703.90, unless the credit union is
exempt under the RegFlex provisions of Part 742.
Investment in $ 107( 1 5)(A) of the FCU Act permits credit unions to purchase certain
Mortgage mortgage loans. A federal credit union may make these investments
Notes only if it has an ongoing program of making real estate-secured loans
and needs comparable loans to complete the packaging of a pool of
loans for sale or pledge on the secondary market (see $701.23.)
Examiners may also refer to NCUA Letter to Credit Unions, No. 96,
dated March 1988.
Mutual Mutual funds. A mutual fund is an open-end investment company

Funds, registered with the SEC to invest money from shareholders. A
Common prospectus discloses the permissible investments and investment
Trusts, Unit transactions for the fund. A money market mutual fund complies with
Trusts SEC regulations limiting investments generally to short-term
instruments.
The net asset value (NAV) represents the value of a share in a mutual
fund. The financial sections of a number of local newspapers, the Wall
Street Journal, or online services report NAVs for mutual fund shares.
Money market funds typically maintain a stable NAV of $1 per share.
Page 12-46
INVESTMENT ANALYSIS
The value of a credit union’s investment in a mutual fund equals the

number of shares it holds (found on the monthly statements of account
activity provided by the trustee) multiplied by the NAV. Credit unions
may redeem mutual fund shares with the open-end investment
company for the NAV.
Each dividend period, the credit union must adjust its investment in
mutual funds and common trusts to fair value. Credit unions must
classify mutual funds having readily determinable fair values as either
trading (if purchased with the intent of sale in the near term) or
available-for-sale (if other than trading.) They cannot classify mutual
funds as held-to-maturity (amortized cost) and should not carry mutual
funds at the lower of cost or market, but at fair value, adjusted through
income (if trading) or through equity (if available-for-sale.)
Common trust fund. A common trust fund is a collective investment

fund maintained by a national bank (12 CFR Part 9.) A common trust
fund that complies with Office of the Comptroller of the Currency
(OCC) regulations limiting investments generally to short-term
instruments is called a short-term investment fund (“ STIF.”)
OCC regulations requires disclosure of the value of a credit union’s

pro-rata interest in a common trust fund at least once every three
months if the fund’s assets are readily marketable. However, investors
may contract for more frequent valuations. OCC regulations allows for
STIFs valuation on a cost basis.
Legality of Credit unions must implement adequate procedures for determining

Fund each fund’s legality. The examiner should review the following:
0 The credit union’s procedures:

- To ensure they meet the needs of the credit union;
- To ascertain that staff reconciles the book balances with the
statement of account each month; and
- To determine that the records are in balance; and
Page 12-47
EXAMINER’S GUIDE
0 The prospectus for each mutual fund investment:

- To determine the investment’s permissibility (i.e., that the fund
invests or is authorized to invest only in investments permitted
by the FCU Act and NCUA Rules and Regulations), and
- The investment meets other requirements.
A number of mutual funds sometimes use hedging strategies to

increase yield. Federal credit unions may not, however, use common
techniques such as writing call options and futures contracts. Fund
managers’ use of such techniques would make the fund illegal.
Character- The examiner should determine that management understands the

istics and nature of the investment in mutual funds. While a mutual fund
Risks investment has the same maturity as the weighted average maturity of
the underlying investments, the NCUA 5300 (call report) and AIRES
permit classification based on the maximum weighted average life
disclosed in the prospectus. If the prospectus does not disclose the
weighted average life, the credit union may use the three to ten year
column. Examiners should take exception if the credit union does not
adhere to its investment policies and internal asset-liability strategy
regarding these investments.
Yield enhancement often motivates investment in long-term

instruments, particularly in times of falling short-term rates. Examiners
should explain to the officials the unsoundness of this practice unless
the maturities and other characteristics of the investments coincide
with the credit union’s asset-liability strategy and liquidity
expectations.
Investments in mutual funds can lose principal; therefore, examiners

should ensure that the officials understand the risks and adopt limits by
investment type that consider both the credit union’s capital structure
and asset size. Significant variance of mutual funds’ net asset values
over a range of interest rate environments may necessitate
establishment of minimal stop-loss guidelines. An adequate
monitoring system should minimize future investment losses.
Examiners should also determine that management considered the

mutual fund’s suitability from an asset-liability standpoint. For
Page 12-48
INVESTMENT ANALYSIS
example, several of the mutual fund net asset values may move
inversely to market interest rate changes or may significantly lag the
market. Credit unions with short-term and highly interest rate-sensitive
share bases may find investments in mutual funds inappropriate.
Fees Examiners should watch for marketing techniques that do not give a
complete and accurate picture of a mutual fund. Even though the SEC
requires certain disclosures, a credit union may incur significant costs
to obtain, maintain, or divest an investment in a fund:
Credit unions may incur front-end and back-end load fees, which
are, in essence, sales commissions. The credit union must pay
front-end load fees at the time of purchase. It pays back-end load
fees if it redeems shares before holding periods specified in the
prospectus.
0 Credit unions may incur management and 'I 12(b)-1 fees (back-end
fees), which the mutual fund assesses shareholders for some of the
promotional expenses. The mutual fund must specifically register
the fee with the SEC and must disclose the levying of such
charges. Such fees can reduce the actual return by 100 basis points
or more.
Complex issues arise over the appropriateness and suitability of

investments in mutual funds or other long-term investments.
Management varies significantly in its understanding of these issues
and in the sophistication of investment practices. Examiners should
consult with their supervisory examiners if problems exist.
Unit A closed-end investment company called a Unit Investment Trust

investment (UIT) repays principal and interest monthly as the underlying
Trusts securities are repaid. At the trust's maturity date, UIT managers sell
underlying investments, and return funds to investors. The cash flow
from a UIT investment often resembles both a direct purchase of a
GNMA and a mutual fund.
The examiner should determine the credit union properly reduces its
investment balance and records interest income in a manner similar to
Page 12-49
EXAMINER’S GUIDE
a direct GNMA purchase. However, the “units” represent ownership,

not the Agency obligation. Therefore, the fair value approach must
account for the value of the investment. The UIT’s market price
determines its value; the closed-end investment company does not
redeem UITs.
cusos NCUA Rules and Regulations 5712.2 specifies that a federal credit
union may invest in shares, stocks or obligations of credit union
service organizations (CUSOs) in amounts not exceeding, in the
aggregate, one percent of the credit union’s paid-in and unimpaired
capital and surplus (total of all shares and undivided earnings plus net
income or minus net losses to date) as of its last calendar year-end
financial report. The same section authorizes credit unions to make
loans to CUSOs in amounts not exceeding, in the aggregate, one
percent of its paid-in and unimpaired capital and surplus as of its last
year-end financial report.
Credit unions frequently establish CUSOs to provide additional

services to members or to other credit unions. Poorly structured or
poorly managed CUSOs can become expensive liabilities and harm the
credit union’s financial condition. Therefore, during the examination,
examiners may review the credit union’s investment in CIJSOs. The
CUSO chapter discusses examination procedures for CUSOs.
For purposes of measuring a credit union’s investment in and loans to

a CUSO in financial statements, credit unions must follow generally
accepted accounting principles (GAAP.) GAAP requires one of three
measurement options (cost method, equity method, or consolidated
financial statements) depending on the degree of ownership a credit
union has in a CUSO.
Federal Federal funds are the excess reserves one bank has available to lend to
Funds another bank enabling it to meet its cash reserve requirements. Federal
funds usually have a maturity of only One business day, although credit
unions may negotiate term federal funds for a longer period. The
federal funds rate represents the rate that the lending banks charge the
borrowing banks for the use of the funds.
Page 12-50
INVESTMENT ANALYSIS
Compared to other money market rates, the federal funds rate is

volatile. Investors closely watch the funds rate as an indicator of the
money market, monetary policy, and general economic conditions
because the federal funds market operates at the center of the money
market and the commercial bank system.
5703.100 authorizes the sale of federal funds to any financial

institution defined in §107(8) of the FCUAct under the deposit
authority contained in that section.
Credit Risk Federal funds are not insured; therefore, the credit union must review
the bank's financial condition and set appropriate policy limits. The
policy must address how the credit union will manage the credit risk of
federal funds sold. (See §703.30(e)).
Besides selling Federal funds to a bank, a credit union can purchase

Federal funds from the bank. Purchasing of funds constitutes a
borrowing transaction by the credit union subject to the borrowing
limitations of $107(9) of the FCUAct.
The examiner should pay particular attention to the method the credit
union uses to transfer funds and record funds' transfers, especially the
related income or expense. The examiner should review internal
control procedures for placing funds, recording transactions, and
reconciling transactions to the confirmation or statement.
Corporate §107(7)(G) of the FCUAct authorizes credit unions to invest in shares,

Credit Unions deposits, and certificates in corporate credit unions. However, credit
unions may not invest in a corporate credit union that does not operate
in compliance with Part 704 of the NCUA Rules and Regulations.
As with its other investments, NCUA expects management to establish

a process for evaluating the corporate's investments and operations,
and to incorporate the amounts and maturities of all authorized
investments in corporates into their written investment policies.
Corporate credit unions offer daily balance share accounts that earn
dividends comparable to market rates offered by other financial
Page 12-51
EXAMINER'S GUIDE
institutions. Many credit unions use this account for short-term

investing because of the daily dividend feature. Most corporates also
offer accounts for clearing share drafts, ATM transactions, money
orders, ACH items, and credit card activity.
Corporate credit unions may offer two capital accounts, which

NCUSIF does not insure: membership capital (MC) and paid-in capital
(PIC), both member and nonmember. Both accounts have a degree of
permanence. MCs have a minimum withdrawal notice of three years.
PICs are callable at the corporate's option and have an initial maturity
of at least twenty years. Credit unions must accept the risk of these
uninsured accounts; therefore, credit unions investing in these accounts
must perform the same due diligence as they perform for other at risk
investments. Examiners should review the due diligence procedures.
Credit unions have available more diverse investment products,

including those offered by corporates. In addition to daily balance
share accounts and certificates accounts, some corporates offer
structured investment products that mimic CMOS and other complex
investments. The examiner should determine that the credit union
consistently adheres to its ALM structure when investing in corporate
credit union investments, as well as other investments. Examiners
should also assure themselves that the directors and management
understand the risks of the investment instruments.
Most corporate credit unions issue monthly or even weekly statements.

The voluminous activity in these clearing accounts may require the
examiner to determine that the credit union fully reconciles all
transaction accounts at least monthly, regardless of the month-end
balance. Examiners should note the lack of prompt reconcilements or
continually carrying over outstanding items from one month to the
next as an area of concern. The credit union can lose control over these
high activity accounts if it does not implement adequate reconcilement
procedures.
Most corporates also offer high-yielding, short-term CDs (30 days.)

Many credit unions continuously roll over these accounts or purchase
new ones. Corporates have reduced the paperwork burden by using
electronic transfers instead of paper certificates; however, credit unions
must reconcile their CD activity.
Page 12-52
INVESTMENT ANALYSIS
Other Credit 3 107(7)(H) of the FCU Act authorizes credit unions to invest in shares,
Unions deposits and certificates of federally insured credit unions. As with
other institutional accounts, the examiner may find it necessary to
review the credit union's process for evaluating the credit risk
associated with such investments.
Other Shares, @107(7)(D) and 107(8) of the FCUAct authorize credit unions to
Deposits, and invest in shares, deposits, and certificates in financial institutions other
Certificates than credit unions.
Thrift Shares Credit unions may invest in passbooks, certificates, or book entry
and Bank confirmation receipts issued by federally insured thrifts, building and
Deposits loan associations, and banks (and non-federally insured banks located
in the state in which the credit union does business.) Credit unions
must retain documentation of these investments.
$703.30 gives the board responsibility for determining the amount and
the specific institutions in which a credit union may invest. If the credit
union invests over the insured limit, the board should specify limits on
the amounts the credit union may invest with each institution.
Management often supports the limits with a credit evaluation that
identifies specific financial criteria, such as capital requirements and
earnings trends. Credit unions with large CD portfolios should obtain
the institution's docket number (FDIC's equivalent to NCUA's charter
number) to determine compliance with the credit union's exposure
limit at each institution. FDIC's website (www.fdic.gov) can provide
the docket number.
Credit unions, the officials, or employees sometimes receive cash

bonuses or merchandise premiums from the institution for new
investments or increases in investments. $703.120 prohibits credit
union officials from accepting these bonuses or premiums on their own
behalf. If examiners suspect the credit union earned a bonus dividend
or premium but find no accounting for it, they should notify their
supervisory examiner, send a positive confirmation letter to the
institution concerned, and report the facts in the confidential section.
Page 12-53
EXAMINER'S GUIDE
Time Credit unions may purchase either negotiable or non-negotiable time

Certificates of certificates of deposit (CDs.) If purchased from the issuing institution,
Deposit the credit union normally contacts and negotiates with the institution
and then transfers the funds directly. If the credit union uses a broker-
dealer for CD purchases, it should reasonably protect itself against
potential loss. These steps include entering into a written contract,
dealing with reputable broker-dealers, evaluating the risk, and using a
custodial agreement.
A large pool of funds, which the broker-dealer invests in a single block

at a federally insured institution, could include the CD purchased. If
so, a custodian normally holds the investment and the credit union
should receive a depository receipt from the third-party custodian
evidencing ownership. The insured institution should also document
the fiduciary relationship between the broker-dealer and the issuer, and
evidence insurability for individual investors of the pool. Part 330 of
Title 12 of the Code of Federal Regulations outlines requirements for
FDIC insurance in "pass-through" situations.
Credit unions should fully address and document insurability in

pooling arrangements. They should not depend solely on the broker to
analyze the soundness and insurability of issuing institutions, nor
should they rely on the deposit insurance coverage as the only basis for
the deposit.
Written investment policies should address criteria and the financial

analysis necessary to ensure sound investment practices. If federal
deposit insurance does not cover all, or a portion, of a deposit, the
credit union should analyze the credit quality of the institution before
making the deposit. Management may contract with a rating service to
assist with this analysis.
Negotiable CDs. Federal credit unions may sell negotiable CDs to

third parties before maturity, subject to the appropriate regulations
governing the issuing institution. Conversely, a credit union could
purchase a CD of an eligible institution in the secondary market. If the
credit union purchased the CD at a premium (e.g., the purchase price
exceeded the original (or accredited) issuer price), federal deposit
insurance does not cover the amount of the premium. Thus, any
Page 12-54
INVESTMENT ANALYSIS
premium remaining on the credit union's books of an institution that

failed before the CD's maturity date may require write off.
Loss of premium also could occur with longer-term investments (e.g.,

zero coupon CDs) that some credit unions purchased in the secondary
market at a significant premium. The credit unions would also face
reinvestment risks.
A credit union does not need to physically hold even a negotiable CD

for safekeeping. However, a security dealer holding negotiable CDs or
"bearer" securities poses risks:
The security dealer can wrongfully transfer the instruments to a

third party. A third party purchasing these instruments for value, in
good faith, and without notice of any adverse claim, becomes a
"bona fide purchaser" under the Uniform Commercial Code and
can retain possession of the instruments.
0 The security dealer could declare bankruptcy or insolvency. The

credit union could "trace" and claim its securities or CDs by
proving ownership of specific instruments. However, negotiable
CDs registered in street name, rather than in the credit union's
name, makes recourse more difficult, if not impossible. The key
here is for the officials to (1) know their safekeeping custodian, (2)
document the financial standing of the safekeeping custodian, and
(3) ensure proper recordkeeping by reconciling monthly
safekeeping reports.
0 If the credit union experiences the loss of a negotiable CD or

security due to a dealer's misappropriation or bankruptcy, surety
will most likely not reimburse for the loss because surety does not
consider the security dealer to be a credit union employee.
Credit unions should balance these risks against the advantages of

having a security dealer hold negotiable CDs and securities in bearer
form for safekeeping; namely, the credit union will have liquid
investments that they can immediately redeem.
Page 12-55
EXAMINER’S GUIDE
Deposit Notes Credit unions may invest in deposit note issues by a §107(8) institution
(e.g., a national bank.) Deposit notes are unsecured obligations of
0107(8) institutions. Federal deposit insurance (to $100,000) covers a
deposit note if the following exist:
0 The bank, instrument, or offering circular states that the obligation

is a deposit;
0 The bank’s call report reports it as a deposit; and
0 The bank pays the FDIC insurance premium.
The issuing bank should state in writing the eligibility requirements in

an offering circular or contract.
Bank Notes A bank note is an unsecured and uninsured obligation of the issuing
bank. Credit unions may invest in bank notes issued by 9 107(8)
institutions with maturities less than five years. (NCUA’s Office of
General Counsel has deemed them permissible as deposits under
Regulation D.) However, credit unions may not invest in debt
obligations of a bank holding company.
The credit union should closely review and document the financial
status of the issuer of any bank note and any deposit note with an
uninsured portion. As with CDs, a broker-dealer may invest a pool of
funds in a 0107(8) institution’s deposit note. The risks previously
specified for CD pooling apply equally to deposit notes.
Eurodollar A Eurodollar deposit is a dollar-denominated deposit in either a

Deposits foreign branch or a foreign subsidiary of a United States bank, or in a
foreign bank located outside the United States. Credit unions may
invest only in foreign branches of parent U.S. depository institutions
and only if the parent U.S. depository institution meets the
requirements of 0107(8) of the FCUAct. Federal deposit insurance
does not cover Eurodollar certificate of deposits.
Yankee A Yankee Dollar deposit is a dollar-denominated deposit in a United

Deposits States branch or subsidiary of a foreign financial institution. Credit
unions may invest in these institutions pursuant to 0107(8) of the FCU
Page 12-56
INVESTMENT ANALYSIS
Act if the branch or subsidiary has federal deposit insurance or

operates in accordance with the laws of a state in which the federal
credit union does business.
Bankers' Federal deposit insurance does not cover time drafts drawn on a bank
Acceptances called bankers' acceptances. $703.100 authorizes investments in
bankers' acceptances issued by $ 107(8) institutions. Bankers'
acceptances represent irrevocable obligations of the bank that arise in a
variety of ways, but generally, corporate customers of the bank use
them initially to "pay" for goods and services. Often, recipients of
banker's acceptances discount and trade them as money market
instruments.
Mutual Credit unions may make deposits or investments in shares or accounts

Savings of mutual savings banks, state banks and trust companies located in the
Banks, State state in which the credit union does business. or in financial
Banks, Trust institutions insured by the FDIC. Financial institutions located in the
Companies
state where the credit union does business qualify as depositories even
though they do not carry federal deposit insurance.
The credit union's board of directors must accept responsibility for

selecting the mutual savings banks, state banks, and trust companies,
and for determining the amount they will invest in each. Examiners
may decide to discuss the advantages of placing funds in insured
institutions. However, they should not take exception if the credit
union invests in non-insured institutions in the state where the credit
union does business, assuming that reasonable limits as to the amounts
invested with each institution govern these investments. As with other
uninsured investments, the credit union must fully analyze the credit
quality of the institution. (See, §703.30(e)).
Loans to Credit unions record loans to nonmember credit unions separately

Other Credit from loans made to their members. They must comply with the
Unions limitations and restrictions (not to exceed 25 percent of paid-in and
unimpaired capital and surplus) set forth in 6 1Oq7) of the FCU Act.
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EXAMINER'S GUIDE
The board, the executive committee, or the credit union's investment

committee must properly authorize loans to nonmember credit unions.
The aggregate of these loans may not exceed the legal limit, and a
signed note must evidence the loan ((§107(7) of the FCUAct.) When
the credit union has not met these requirements, the examiner should
inform the officials, reach appropriate agreements, and comment in the
examination report.
State and Credit unions may invest in state and municipal securities authorized
Municipal in 0107(7)(k) of the FCU Act. Most municipal (muni) bonds receive a
Obiigations credit rating fiom a rating service (a nationally recognized statistical
rating organization.) NCUA Rules and Regulations 5703.1OO(f)
permits investment only in those muni bonds rated in the top four
ratings categories (e.g., BBB, A, AA, or AAA.) When evaluating
credit risk, examiners should review bond ratings assigned to munis in
the portfolio. Further, 0 107(7)(k) limits obligations of any one issuer,
except general obligations of the issuer, to no greater than 10 percent
of the credit union's unimpaired capital and surplus. This means
revenue bonds, even when insured, are subject to the percent limit.
States and municipalities generally issue their obligations at lower

interest rates because of the unique tax advantage to security holders.
Since credit unions do not pay income taxes, there is no offset to the
lower yield and, therefore, no financial advantage to investing in these
tax-exempt securities. Taxable revenue bonds have no tax exemption,
but generally carry greater credit risk than do general obligation bonds.
Repurchase In a repurchase transaction the credit union agrees to purchase a

Transactions security from a counterparty and to resell the same or an identical
security to that counterparty at a specified future date and at a specified
price. 8703.1OO(i) authorizes credit unions to enter into repurchase
transactions within the following limitations:
0 The repurchase securities consist of permissible investments for a

federal credit union;
The credit union receives a daily assessment of the market value of

the repurchase securities, including accrued interest, and maintains
Page 12-58
INVESTMENT ANALYSIS
an adequate margin that reflects a risk assessment of the repurchase

securities and the term of the transaction; and
0 The credit union has entered into signed contracts with all
approved counter parties.
The examiner may review the credit union’s file to determine that it
contains a written custodial agreement as well as copies of the
safekeeping receipts. The Federal Reserve Book Entry System could
record the credit union as the owner of the security. As with physical
securities, third-party control further minimizes custodial risks.
The credit union entering into the repurchase transaction usually

requires collateral with a security value in excess of the amount of cash
delivered, an amount often called the “haircut.” For example, for
$1,000,000 in cash, the credit union may require securities valued at
$1,020,000 to collateralize the transaction. This “haircut” generally
ranges from two to five percent and protects the cash participant’s
collateral position if fair values change. The credit union must monitor
the collateral’smarket value. If the value decreases relative to the cash
outstanding, the credit union should request a margin call and require
the securities lender to provide additional collateral. Responsibility for
repaying the funds ultimately rests with the counter party to the
transaction, making that party’s reputation (ability to pay) important to
others in the transaction. FDIC insurance does not cover repurchase
agreements and a secondary market for repurchase agreements does
not exist.
Commitments Under $703.100, credit unions may not invest in forward

to Purchase commitments to purchase or sell a security. Commitments to purchase
or Sell or sell securities (forward commitments) represent contingent
Securities liabilities.
$703.100 permits the purchase or sale of a security as long as the

delivery of the security is by regular-way settlement. Regular-way
settlement means delivery of a security from a seller to a buyer within
the time frame that the securities industry has established for that type
of security.
Page 12-59
EXAMINER'S GUIDE
For example, regular-way settlement of mortgage-backed securities

occurs once a month according to a schedule of The Bond Market
Association (PSA) settlement dates. While a regular-way settlement in
a mortgage-backed security transaction is pending, the credit union
should account for the transaction in accordance with GAAP.
Standby Generally, a standby commitment consists of an agreement to purchase

Commitment or sell a security at a future date, whereby the purchaser must accept
delivery of the security at the seller's option. To induce the purchaser
to buy at the seller's option, the seller pays a non-refundable option
premium called a "commitment fee." If the market price of the security
on settlement date has increased, the seller would not exercise the
option, but would sell the security elsewhere. The purchaser would
then recognize the commitment fee as income.
Examiners should review documentation required by 5701.2 1(i) for

long positions in financial put option contracts. $703.1 lO(a) prohibits
all financial derivatives, except as provided under $70 1.21(i) for the
purchase of certain financial put option contracts (also called standby
commitments) to manage risk of loss through a decrease in value of its
commitments to originate real estate loans.
Cash Forward A cash forward agreement represents a firm commitment for a

Agreement purchaser to buy and a seller to sell an agreed-upon security on a
specified settlement date. A commitment fee does not pass from the
seller to the purchaser. A cash forward agreement extends beyond the
term of a regular-way settlement; therefore, a federal credit union may
not enter into a cash forward agreement for a security.
Short Sale A short sale is a forward commitment to sell a security that the seller
does not own. Short sales sellers speculate that market prices will
decline before the settlement date. Thus, they can purchase a less
expensive security to meet the commitment to sell and realize a gain.
If, however, the market price increases, the seller incurs a loss in
meeting the commitment. 5703.1 10 prohibits a federal credit union
from engaging in short sales.
Page 12-60
INVESTMENT ANALYSIS
Pair-Off A pair-off transaction matches or nets the commitments to purchase

Transactions and to sell securities. Participants in pair-off transactions often do not
take delivery of the security purchased, but speculate that the market
price will increase before settlement date resulting in a gain from its
sale. Many times, participants make the commitment to sell and the
commitment to purchase on the same day. §703.100(1) specifies
requirements for a credit union to trade securities including when-
issued trading and pair-off transactions. Credit unions must record
these transactions at fair value on the trade date.
Reverse A reverse repurchase transaction (reverse repo) is a transaction by a

Repurchase credit union in which the credit union agrees to sell a security to a
Transactions counter party and to repurchase the same or an identical security from
that counter party at a specified future date and at a specified price. In
effect, the credit union incurs a borrowing collateralized by a
marketable security.
Credit unions may use funds generated by a reverse rep0 to (1) meet
liquidity needs, such as share or loan demands, or (2) purchase other
securities with a yield higher than the borrowing rate of the reverse
rep0 (often called a spread trade or “arbitrage.”) When engaging in the
latter, the credit union must comply with statutory limitations. Any
security purchased with the funds obtained from the transaction or the
securities collateralizing the transaction must have a maturity date not
later than the maturity date for the reverse rep0 transaction and be
permissible investments under Part 703. A reverse rep0 transaction is a
borrowing transaction subject to the aggregate borrowing limit of 50
percent of a credit union’s unimpaired capital and surplus specified in
0107(9) of the FCU Act.
Example: A credit union owns a $1,000,000 Treasury security with a
7 percent coupon rate, valued at par. The credit union enters into a
reverse repo, borrowing $1 million, collateralized by the Treasury
security, at 5.5 percent for 90 days. The credit union also purchases a
90-day time certificate paying 6.0 percent, also maturing in 90 days.
Thus, the credit union earns a 0.5 percent spread (the difference
between the cost of the funds borrowed, 5.5 percent, and the income
earned, 6.0 percent.)
If the examiner finds a credit union entering into reverse repo

transactions with the intent of earning a positive spread by reinvesting
Page 12-61
EXAMINER’S GUIDE
the funds, the examiner should determine if the credit union actually
realizes a positive earnings spread.
The credit union must retain signed contracts with all approved
counter parties. Examiners should encourage master contracts (i.e.,
The Bond Market Association (formerly called PSA) Agreements)
covering the dates and responsibilities of each party. Confirmations
under the master contract constitute evidence of individual reverse
rep0 transactions. A trade sheet, rather than written agreements
between a broker and the credit union, does not constitute acceptable
evidence.
Since reverse repos represent borrowings by the credit union, credit

unions must record them as notes payable and the board of directors or
executive committee should approve them. The investment committee
cannot authorize borrowing through a reverse repo.
The credit union must properly record reverse repos, the income
applicable to the related investment, and the interest on the notes
payable. GAAP provides guidance on the proper accounting treatment
for repurchase transactions (SFAS No. 125 and 140.)
For examination analysis and CAMEL-rating purposes, examiners

must use GAAP determined total assets. Examiners should note that
the existence of reverse repos can (1) cause material changes in the
asset size of the credit union, (2) affect any ratio that uses average
assets or total assets, and (3) distort the trends and ratios of the most
recent Financial Performance Report (FPR.)
During the period (usually a short duration of 90 to 120 days) of

spread transactions, reverse repos will increase total assets by the
committed amount. The investment, which may be material, remains
on the credit union’s books while, at the same time, the credit union
establishes a notes payable account and an asset account for the
amount of the transaction. At the end of the transaction term, the credit
union will reduce the liability account and the asset account
accordingly, while the investment account remains unchanged.
As an alternative, credit unions may engage in securities lending

transactions (i.e., “bonds borrowed” agreements.) These generally
Page 12-62
INVESTMENT ANALYSIS
consist of very short-term lending activities in which the credit union

releases control of investment grade securities in exchange for a
promise for repayment, and receives a fee for the related risks. In some
cases, the credit union must record a securities lending transaction in
its financial statement, similar to a reverse repurchase transaction, as a
notes receivable and a securities lending (“bonds borrowed”) credit.
The examiner should ensure that the credit union adequately discloses
any securities lending (“bonds borrowed’) transactions. In addition,
credit union officials should review the borrower’s financial condition.
Adjusted 5703.1 lQ(b)prohibits credit unions from engaging in adjusted trading.

Trading Adjusted trading also may violate applicable statutory provisions
because it does not (1) meet “full and fair disclosure” requirements, (2)
record losses in a timely manner, or (3) fairly present the financial
condition to members, creditors, and the regulator.
When reviewing investments, the examiner should look for indications

that the credit union purchased or sold securities at other than “at
market” prices, which could evidence adjusted trading. The examiner
should test several purchases or sales if indications exist that a security
transaction was not at market. Examiners can verify sales prices using
the Wall Street Journal or another reliable paper as of the sales date, or
by contacting a broker-dealer.
The examiner should analyze problems noted. In the past, problems in

adjusted trading occurred with broker-dealers who were not regional or
who did not have a reputation for knowing their customers.
The two most common methods of adjusted trading are:
0 Adjusted trading or overtrading. When market prices decline,

credit unions may face investment losses if (1) they must sell their
securities or (2) must meet commitments to purchase securities
without having available funds to do so. To avoid these losses, a
credit union might enter into an agreement with its broker to
transfer or to hide the loss in another transaction. Such an adjusted
trade violates NCUA Rules and Regulations.
Page 12-63
EXAMINER'S GUIDE
Example: The credit union owns Investment A with a book value

of 97 and a market value of 95. The broker owns Investment B
with a fair value of 9 1. Needing funds, the credit union decides to
sell Security A, but does not wish to incur the loss of two points.
The broker agrees to purchase the investment at book value;
however, in return, the credit union agrees to purchase Security B
using a forward commitment for 93; or two points over market.
The credit union is speculating that the fair value of Security B
will increase by the settlement date. If that happened, the credit
union would sustain no loss and would not record the transaction.
0 Fee trading. Fee trading, or reposition trading, represents a form

of adjusted trading. Fee trading uses similar mechanics except the
credit union pays a fee or "up front" money to the broker. Using
the example above, the broker would purchase Security A at 97,
but would require the credit union to forward a two-point fee. The
fee ensures the credit union's purchase of Security B on settlement
date. When the credit union purchases Security B, the broker
returns the fee.
If the investment review discloses possible adjusted trading, the

examiner should contact the supervisory examiner. In any case, the
examiner should exercise additional scrutiny should there appear to
be indications of adjusted trading.
Impermis- The examiner may find that a credit union has investments not
sible or permitted by statutes or regulations. Examples include investments in
Unsuitable commercial paper, a stock-based mutual fund, or loans to other credit
Investments unions in excess of the legal limit. The credit union should liquidate
the investments as soon as possible. If the divestiture most likely will
result in a material loss, the examiner should consider the investment's
maturity and safety, as well as its effect on the credit union's financial
condition. When examiners find impermissible investments, they
should contact their supervisory examiner. Credit unions must also
notify the surety company of the illegal investment.
In most cases, the examiner and officials can resolve the problem
during the examination. If not, the examiner should address it with the
officials and, if material, in the examination report. Examiners should
reserve administrative action only for extreme cases where other
supervisory efforts fail.
Page 12-64
INVESTMENT ANALYSIS
If the examiner determines that the credit union holds permissible, but
not suitable, investments for the credit union's balance sheet, the
examiner should contact the supervisory examiner before requiring the
write-down or sale of the investments.
I nvestment The goal of trading securities is to take short-term trading profits from
Trading an increase in fair value. Investors may earn sizable trading gains as
interest rates decline; however, rate increases typically result in losses.
NCUA Rules and Regulations §703.30(k) sets forth policy

requirements and 8703.1OO(1) sets forth other requirements for a
federal credit union to trade securities. Credit unions should know the
market risks associated with trading, and adopt policies and procedures
to limit risk to an acceptable level. The board of directors must
approve a written trading security policy that includes, at a minimum,
the provisions listed in this section. Credit unions must maintain
consistency with GAAP guidance in accounting for trading securities.
The examiner should review the credit union's investment activity and
determine if the credit union is trading. This analysis should include a
review of the following:
0 The broker's monthly statement to determine proper booking of all

activity;
0 The month-end safekeeping statement and transaction reports;
0 The source documents, such as the broker confirmations, to
adequately analyze trading activity; and
0 The cash and corporate credit union account transactions to
determine the existence of large security purchases or sales.
Credit unions involved in trading must have adequate reserves to

absorb potential trading losses and should establish loss parameters
based on the level of reserves. If unsafe and unsound trading policies
or procedures exist, the examiner should consult with the supervisory
examiner to develop a plan for resolving the problems.
Before a credit union's board engages in trading securities, they must

develop and adopt a written securities trading policy that at a minimum
specifies the following:
Page 12-65
EXAMINER'S GUIDE
Internal controls, including appropriate segregation of duties;

Individuals who have purchase and sale authority;
Trading account size limits;
Allocation of credit union's cash flow to trading accounts;
Stop loss or sale provisions;
Dollar limits for the purchasing of specific types, quantities, and
maturities;
Limits on the length of time an investment may remain in the
trading account;
Monthly reports for the board of all purchase and sale transactions,
and the resulting individual transaction gain or loss (credit unions
should report purchases and sales to trade date); and
A requirement for recording at fair value on the trade date any
security purchased for trading purposes.
See the Classification of Securities SFAS 1 15 section for transfers to

or from the trading category.
and - Critical Input tab
References - Statement of Income
- Review Considerations
- ALMTab
- Solvency Evaluation
- Investment Trend
- Investment Maturity
- Investment Classification
- Investment Controls Questionnaire
- Credit Union Service Organization Controls
- Questionnaire
- Certificate Review
- Amortizing Investment
References
§§§107(7), 107(8), 107(9), and 107(15) - Powers
§§304 and 305, Central Liquidity Facility
Page 12-66
INVESTMENT ANALYSIS

$701.2 1(i), Put Options in Managing Increased Interest-
Rate Risk for Real Estate Loans Produced for Sale on
the Secondary Market
$7 12, Credit Union Service Organizations
Part 703 - Investment and Deposit Activities
Part 725 - Central Liquidity Facility
Federal Credit Union Bylaws
Accounting Bulletin 94- 1
SFAS 107
SFAS 115
SFAS 125
SFAS 133
SFAS 140 - Administrator's Letter No. 29, dated 4/17/79;
Custodial/Safekeeping Accounts
NCUA Letter No. 57, dated 6/24/8 1, Investment Risk
NCUA Letter No. 79, dated 5/29/85, Mutual Funds
NCUA Letter No. 130, dated February 1992, Risks of Long-
Term Investments - Mortgage Derivative Products
NCUA Letter No. 139, dated September 1992, Collateralized
Mortgage Obligations
NCUA Letter No. 146, dated August 1993, New Investment
Products
NCUA Letter No. 155, dated April 1994, Permissible
Investments for Mutual Funds
NCUA Letter No. 157, dated September 1994, Broker
Selection, Security Safekeeping
NCUA Letter No. 169, dated April 1995, Divestiture of
CMOs and REMICs
NCUA Letter No. 00-CU-05, dated September 2000,
Investments in Brokered Certificates of Deposits
IRPS 98-02, dated 1998, Supervisory Policy Statement on
Securities Activities and End-User Derivatives Activities
NCUA Investment Report No. 1, dated 1/31/89, Mortgage
Pass-Through Securities
NCUA Investment Report No. 2, dated 4/10/89, Broker
Selection
NCUA Investment Report No. 3, dated 7/19/89,
Collateralized Mortgage Obligations (CMOs)
Page 12-67
EXAMINER'S GUIDE
- NCUA Investment Report No. 4, dated 12/1/89, Stripped

Mortgage-Backed Securities
- NCUA Investment Report No. 5, dated 4/1/90, Short-Term
Investments for Federal Credit Unions
- NCUA Investment Report No. 6, dated 9/1/90, Treasury-
Backed Stripped Securities
- NCUA Investment Report No. 7, dated February 1991,
Deposit Notes
- NCUA Investment Report No. 8, dated July 1992, The New
Investment Regulation
0 NCUA Investment Hotline - 1-800-755-5999 (703-5 18-6620
Washington, DC area)
0 Investment Guidance Paper(s), Developed by OSPSP and RCMS
Staff
0 Using the Regional Investment Specialist, dated February 1999
Page 12-68
GLOSSARY OF INVESTMENT TERMS - APPENDIX
12A
This section contains definitions of financial terms commonly used in
investments and asset-liability management. Standard dictionaries do
not contain the definitions of many words and phrases used throughout
the investment industry; therefore, this glossary was compiled to assist
the examiner in understanding specialized industry-specific words.
Accretion of a Discount: the accounting recognition of earnings on a discount bond

in anticipation of receipt of par at maturity.
Accrued Interest: the amount of coupon interest accumulated on a security between

coupon payment dates, or between issuance and the first coupon payment date. The
purchaser of the bond pays to the seller the market price plus accrued interest.
Accrued interest is calculated using the accrued interest (day count) type for the
security.
Accrued Interest Types: the day count used to calculate the accrued interest and the
coupon period. A day count type is displayed as DDIYYY, where DD denotes the
number of days per month elapsed in the coupon period and YYY denotes the
number of days per year (for calculating the coupon period). The day count does not
include the settlement day. Common day count types include:
WACTIACT:actual days for month and year (365 or 366 days).
o301ACT: each month has 30 days and the year has 365 or 366 days.
0301360: each month contains 30 days and a year has 360 days.
0301365: each month has 30 days and a year has 365 days.
Actuals: the physical or cash commodity, as distinguished from a commodity

futures contract or derivative contract which has a value based upon an underlying
commodity or index. Forward contracts with an immediate delivery date are called
spot contracts. Actuals are also called spot commodities or cash commodities.
Adjusted Trading: a prohibited method of deferring or hiding a loss on the sale of a

security. Generally, a security is sold at its book value, which is above the market
value, and another security is purchased (or a commitment is made to purchase
another security) at a price that also is above the market value.
Advance Commitment (Conditional): a written promise to make an investment at

some time in the future if specified conditions are met.
Agent: a person or firm authorized by another (called a principal) to act on hisher

behalf. An agent in an investment transaction does not own the security, but instead,
represents the employer’s interests and is subject to control by the employer.
Purchase confirmations should state whether the broker acted as agent (representing
the credit union) or as principal (acting at arms length from the credit union). See
“Principal”.
Page 12A-1
EXAMINER’S GUIDE
Amortization: a reduction in an investment due to periodic payments of part of the

principal before final maturity, usually made in accordance with a predetermined
schedule of installment payments. Compare “Prepayment”.
Arbitrage: the simultaneous purchase in one market and sale in another of an

investment. The arbitrageur hopes to profit from the price differences between
different markets. Arbitrage has been used in the credit union industry to describe a
position in a security that is funded by a reverse repurchase agreement (see,
“Carry”, “Positive Carry”, “Negative Carry”); however, there is price risk in such
a position when the term of the borrowing is shorter than the maturity of the
investment. There may also be credit risk in such a position if the investment is not
issued or guaranteed by the U.S. Government.
Ask Price: the lowest declared price at which a seller is willing to sell a security at a
particular time. Opposite of “Bid”. Same as “Offer”.
Asset-Backed Security (ABS): a security that is collateralized, typically, by loans,

leases, unsecured receivables, or installment contracts on personal property. Asset-
backed securities are not permissible investments for federally chartered natural
person credit unions.
Assignment: the transfer of ownership of a right or a contract from one party, the
assignor, to another, the assignee.
At-the-Money: describes an option when the current trading price of the underlying
security is the same as the option’s strike price.
At Market: the going bid price of a security at any given time.
Auction: a competitive process by which an issuer sells its securities, rather than
selling at a negotiated, or non-competitive, price.
Auction Stop Out: the lowest or cheapest price (corresponding to the highest yield)
at which securities are awarded in a multi-price auction. The Treasury Department
has used one-price auctions for two- and five-year Treasury Notes, resulting in the
award of securities to each winning bidder at the stop-out yield (the highest yield).
Average Life: the weighted average time to principal repayment. It is useful to

describe the life of an instrument as an approximation of a single maturity.
Backup Bid: see “Take Out Bid”
Bad Delivery: a delivery of securities that does not fulfill the requirements for good
delivery.
Bailment for Hire: a obsolete name used for a custodial (or safekeeping) agreement
between a custodian (or safekeeping institution) and its customer (or the beneficial
owner of the security).
Balloon: a final payment at maturity on a security (or loan) that is much greater than
the previous payments. For example, a 7-year balloon loan is amortized on a 30-year
schedule to make the payments affordable, but has a large payment of the remaining
principal balance (balloon) due at the end of the 7 years. A balloon feature is usually
associated with real estate loans and mortgage-backed securities.
Page 12A-2
GLOSSARY OF INVESTMENT TERMS - APPENDIX 12A
Band: see “PAC” (Planned Amortization Class).
Banker’s Acceptance: a time draft or bill of exchange accepted by a bank. It

represents an irrevocable obligation of the accepting bank to guarantee payment of
the draft at maturity at the face value. These instruments are uninsured and are sold
at a discount from face value prior to maturity.
Bank Deposit: an account with a bank, including a checking, time, interest or

savings account. Bank deposits with certain institutions are authorized in the Federal
Credit Union Act. Some deposits are insured up to $100,000, while other deposits
are not insured. For example, Federal funds, banker’s acceptances and certain bank
notes have been determined by general counsel to be bank deposits under the FCU
Act and thus to be permissible, but not insured, investments.
Bank Note: an unsecured and uninsured obligation of the issuing bank. General
counsel has determined that bank notes with maturities less than five years are
deposits under Regulation D and thus are permissible investments.
Basis: 1) a price expressed in terms of yield-to-maturity or annual rate of return, or a

term to describe the yield to expected maturity, as in the expression “GNMAs are
trading on a 9- 1/2% basis” or a 10 percent bond selling at 100 has a 10 percent basis;
2) the difference between the spot or cash price of a commodity and the price of the
nearest futures contract for the same or a related commodity, e g , basis is usually
computed in relation to the futures contract next to expire and may reflect different
time periods, product forms, qualities, or locations; 3) used in the phrase “long the
basis” or “short the basis” to indicate a cash market position hedged with a futures
contract. See “Long the Basis” and “Short the Basis”.
Basis Point: a measurement of yield for fixed income securities. One basis point
equals 1/100 of one percent. For example, the difference between 8.00 percent and
8.25 percent is 25 basis points.
Basis Risk: 1) the risk that rates on assets and liabilities will react differently to
changes in interest rates, e.g., the investment coupon linked to the Federal Home
Loan Bank’s 1 Ith District Cost of Funds (COFI) will not be perfectly correlated with
the funding rate offered on a money market share account tied to the overnight
Federal fund rate; 2) the risk associated with an unexpected widening or narrowing
of the difference in rates or prices between the time a hedge position is established
and the time that it is lifted.
Beneficial Owner: the entity that is entitled to receive some or all of the benefits of
ownership, including the cash flow, even though title to the security may be in
another name, e.g., a nominee name. Title is frequently held in a name other than
that of the beneficial owner for safety or convenience of transfer.
Bid Price: the highest declared price at which a buyer is willing to purchase a
security at a particular time. Opposite. of “Ask” or “Offer”.
Bid and Asked: usually refers to the inside bidask quotation, i.e., the best bid and
best offer in the market. From a single dealer, the bidask represents the prices at
which the dealer stands ready to purchase and to sell, often referred to as making a
two-way market quotation. See also “Quotation” and “Take Out Bid’.
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Bloomberg: an information vendor system that provides financial market

information and performs various analyses of securities. There are a number of
private companies or publications that provide a source of basic information and
analytic detail about securities.
Board of Trade: an exchange or an association of persons, whether incorporated or

unincorporated, that is engaged in the business of buying and selling any commodity
or receiving the same for sale on consignment.
Bond: a certificate or evidence of a debt on which the issuer promises to pay a

specified amount of interest and to repay the principal on the maturity date.
Examples include Treasury bills (original maturity under one year), Treasury notes,
Treasury bonds (original maturity over 15 years), agency debt, and mortgage backed
securities.
Bond-Equivalent Yield: a comparable measure of the return over the life of a bond
or Treasury bill or other discount instrument, assuming it is purchased at the ask
price and the return is computed using a semi-annual interest formula and an actual-
day year. Other rates of return cannot be compared directly with the bond-equivalent
yield; e.g., a discount rate of return is calculated by using the par amount rather than
the purchase price, by using another formula, and by using a 360-day year rather
than an actual-day year. The Securities Industry Association has published standard
securities calculation methods for fixed income securities formulas.
Book Entry Security: a security that is not represented by a physical certificate. The
beneficial owner (or the custodian) of the security is recorded on an electronic
system on which the terms and conditions of the security exists. The method of
computerized entries eliminates the need for physical certificates. For example, the
Treasury and certain government sponsored enterprises use a book-entry system
maintained in computerized records at the Federal Reserve Banks in the names of
member banks. A member bank, in turn, keeps records of securities held for
1) beneficial owners with whom it has a direct custodian agreement and 2) other
custodians that hold as nominees for others that, in turn, maintain records of
beneficial ownership or other custodians.
Book Entry Transfer: a system of custody and transfer of securities through the
electronic delivery and settlement of transactions.
Book Value: the value at which a held-to-maturity security is shown on the holder's
balance sheet. Book value may differ significantly from market value.
Broker: an entity that engages in securities transactions for the account of others. A
broker does not buy and sell securities for its own account, as contrasted to a dealer
that trades for its own account. A broker charges a commission for the service which
it provides.
Broker-Dealer: an entity engaged in securities transactions for its own account and
for the account of others. A broker-dealer may act as agent (broker) or principal
(dealer). The purchase confirmation will state whether the broker-dealer acted as
broker (agent) or dealer (principal) for the transaction.
BullPet Bond: a debt security that returns 100 percent of principal on the maturity
date.
Page 12A-4
Call: 1) an option contract granting the buyer the right but not the obligation to
purchase (call) a specified quantity of a security at a specified price (the exercise or
strike price) and time (the exercise style). Typical option terms provide for exercise
a) at any time until the stated expiration date of the contract (American exercise
style), orb) only at the stated expiration date (European exercise style). Such an
option is bought in the expectation of a price rise above the strike price. If the price
rise occurs, the purchaser will exercise the option. If the rise does not occur, the
purchaser will let the option expire and will lose the purchase price of the option,
that is, the option premium. 2) an embedded call in a security grants the issuer the
right to retire or “call away” all or part of the security at a specific price (the call
price) and at a specific time prior to its contractual maturity date. The ability to call
the security is an “option” that belongs to the issuer of the bond. Common call
features include a) callable only on specific call dates, orb) continuous, that is,
callable anytime, usually after a lockout period, which is a time period when a call
cannot occur.
Call Date: the date or dates on which a security may be redeemed by the issuer at a
pre-specified price.
Call Feature: a provision on a bond which entitles the issuer to redeem the bond at
face value or other price before the maturity date.
Call Loan: a short-term loan of temporarily liquid funds by banks to securities

dealers and brokers.
Cap: 1) an embedded option in a floating-rate security that places a rate ceiling

(specifying the highest interest rate that will be paid) on the floating rate coupon.
2) a stand-alone option contract (usually written as a swap) that pays the holder of
the cap an amount equal to the notional principal amount times the excess of the
market rate over the cap rate. A cap usually consists of a strip of caplets (that is, a
series of options with sequential expiration dates). Each caplet is an option on rates
for a single period of time. 3) for risk management purposes, the quantitative limit
placed on the position that a participant in a funds or securities transfer system can
incur during the business day.
Carry: the interest cost of financing securities positions, calculated by subtracting

the cost of funds borrowed to finance the securities from the interest earned on the
securities.
Cash Commodity: see “Actuals”
Cash Flow: 1) the stream of principal and interest payments on a security. 2) the
amount of cash derived over a certain measured period of time from the operation of
income-producing property after debt services and operating expenses, but before
depreciation.
Cash Forward Agreement: a cash transaction in which a buyer and seller agree
upon delivery of a specified amount of a security at a specified future date. Also
known as a firm commitment. See “Commitment”.
Cash Market: traditionally, denotes the market in which commodities are traded,
for immediate delivery, against cash. The cash market in which securities trade for
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immediate delivery is contrasted with the futures markets in which securities trade
for future delivery.
Cash Price: a price quotation obtained or a price actually received in a cash market.
Same as “Spot Price”.
Cash Settlement: 1) money market securities purchased for delivery on the same
day the trade is made. 2) a method of settling an option contract whereby the seller
pays the buyer a cash amount determined according to a procedure specified in the
contract based on the cash value of the underlying instrument at expiration. Futures
contracts also may specify cash settlement in lieu of physical delivery at maturity.
CATS (Certificate of Accrual on Treasury Securities): an obsolete form of zero

coupon Treasury security. See “STRIPS”.
Certificate of Deposit (CD): a time deposit issued by a bank that pays interest
periodically or at maturity. While principal may be paid according to a schedule,
typically principal is repaid in a single payment on the maturity date. “Brokered
CDs” are marketed through a deposit broker to investors. By way of comparison, a
“direct CD” is purchased from the issuing financial institution without the use of a
deposit broker. A negotiable CD can be sold by the holder to another party in the
market prior to maturity. In contrast, a non-negotiable CD cannot be transferred, but
may be redeemed with the issuer subject to any interest penalty.
Cheap: Wall Street vernacular for the relative value of one security to another in
terms of its historical price relationship. If a security is cheap, it is underpriced
relative to another security. See also “Rich”.
Chicago Board of Trade (CBOT): an exchange which is designated as a contract

market in various commodity futures and option contracts. The CBOT introduced
GNMA futures contracts in 1975 (no longer traded) and now is an active contract
market for futures contracts in Treasury securities.
Churning: excessive purchases and sales by a broker in the accounts of one or more
customers for the purpose of generating commissions while disregarding the
interests of the customers.
Clean-up Call: the redemption of the remaining outstanding principal of an asset-

backed security that is triggered by the reduction in outstanding principal through
amortization or prepayment to a specified percentage of the original principal.
Clearing/Clearance:the process of transmitting, reconciling and in some cases

confirming payment orders or security transfer instructions prior to settlement.
Sometimes the terms are used to include settlement.
Clearing Corporation: 1 ) any person who acts as an intermediary in making

payments or deliveries or both in connection with transactions in securities,
generally serving to centralize and reduce the number of settlements of securities
transactions. Major clearing corporations for fixed income securities include the
Government Securities Clearing Corporation and the Mortgage-Backed Securities
Clearing Corporation. 2) a corporation organized to function as the clearing house
for an exchange, that may interpose itself as the buyer to every seller and the seller
to every buyer.
Page 12A-6
Clearing Member: a brokerage concern entitled to use the services of a clearing

corporation.
Clearing Organization: usually a brokerage concern which clears the transactions

of another brokerage concern.
Closed Position: forward or futures contracts which have been offset in full are
considered “closed” because the obligations cancel each other out.
Closing Price: the price (or price range) at which transactions are made just before
the end of trading on a given day. See also “Settlement Price”.
Collar: 1) a maximum and a minimum interest rate on a floating rate bond. This is
comprised of two embedded option positions: a short cap on rates and a long floor
on rates. See “Embedded Option”, “Cap”, and “Floor”. 2) a swap contract that
eliminates the downside risk below the floor price (or rate) and eliminates the upside
participation above the cap price (or rate). This is comprised of a long floor on price
(or rate) and a short cap on price (or rate).
Collateral: an asset pledged to a lender until a loan is repaid. If the borrower

defaults, the lender has the right to seize the collateral and sell it to pay off the loan.
Collateralized Mortgage Obligation (CMO): a bond that represents a partitioned

ownership of a mortgage pool. CMOs are issued by a trust which holds mortgage-
backed securities as collateral. The trust issues several different classes of CMOs,
called tranches. Tranches have different maturities, coupons, and risks. A common
CMO structure separates pools into short-, medium-, and long-term classes, which
divides the ownership of the MBS pools into sequential-pay tranches; principal is
paid to the class with the highest priority claim on principal payments (the short-
term class, often called the A tranch) until all bonds of that priority have been
redeemed; then, principal is paid to the next highest priority class (the medium-term
class, often called the B tranch) until all bonds of that priority have been redeemed;
finally, principal is paid to the long-term class (often called the C tranch). This
structuring creates a series of bonds of distinct expected maturities. There are many
different structures that specify complex cash flow priorities of principal and
interest. A CMO is also referred to as a REMIC (Real Estate Mortgage Investment
Conduit).
Commercial Mortgage-Related Security: a mortgage related security where the

mortgages are secured by real estate upon which a commercial structure is located.
Commercial Paper: a short-term unsecured promissory note issued by a corporation

for a maturity specified by the buyer.
Commitment: an agreement to buy or sell a security at a future date, subject to

compliance with stated conditions. Applies to mortgage-backed securities. See
“Cash Forward Agreement”,” Standby Commitment”, and “Take-Out
Commitment”.
Commitment Fee: see Fee.
Commodity Futures Trading Commission (CFTC): a federal regulatory agency

charged and empowered under the Commodity Exchange Act with regulation of
futures trading in all commodities.
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Common Trust: a collective investment fund maintained by a national bank under

12 CFR part 9.
Competitive Bid: 1) bid tendered in a Treasury auction for a specific amount of

securities at a specific yield or price. 2) bids solicited from one or more syndicates
by issuers such as municipalities and public utilities for new issues.
Conditional Prepayment Rate (CPR): same as “Constant Prepayment Rate”.
Confirmation: the document (or process) whereby a market participant notifies its
customers of the details of a trade and, typically, allows time to affirm or to question
the trade which had previously been agreed to verbally.
Connie Mac: a colloquial term for securities collateralized by pools of conventional

mortgages. See “Conventional Loan”.
Constant Maturity Treasury (CMT): a construct to obtain a bond equivalent yield

for a fixed maturity. Yield curves on U.S. Treasury securities are constructed daily
by the Treasury Department. The curves are fitted based on the closing market bid
yields of actively traded Treasury securities. Values are read (or interpolated using
cubic spline fitting) from the yield curve for constant remaining maturities of 1 , 2 , 3 ,
5,7, 10, and 20 years. The yield for one and three year CMT’s are often used as
indexes for variable rate securities.
Constant Percent Prepayment (CPP): an infrequently used term that expresses

single monthly mortality (SMM) on an annualized basis without correcting for the
effects of compounding. CPP is SMM multiplied by 12.
Constant Prepayment Rate (CPR): a measure of the prepayment rate at which

mortgage collateral is expected to prepay, expressed as an annual percentage of the
remaining collateral. Sometimes called “Conditional Prepayment Rate”. CPR
reflects the result of compounding on SMM. If a constant percent of the outstanding
balance prepays each month, the dollar amount prepaid declines over time. Using a 4
percent SMM, on a $100,000 mortgage, $4,000 ($100,000 x .04) would prepay in
the first month, but only $3,840 ($96,000 x .04) would prepay in the second month.
In the first year the CPR would be 38.73 percent, i.e., [ 1 - (1 - .04)”] and the
remaining mortgage balance at the end of the first year would be $61,270, i.e., [(l -
.3873) x 100,0001.
Contract: 1) a bilateral agreement between buyer and seller. 2) a term of reference

describing a unit of trading for a commodity for future delivery.
Contract Grades: those grades of a commodity which have been officially

approved by an exchange as deliverable in settlement of a futures contract.
Contract Market: a board of trade designated by the Commodity Futures Trading

Commission as a contract market under the Commodity Exchange Act. Contract
markets include: 1) a futures contract in a specified commodity or financial
instrument; 2) an option contract on a specified commodity or financial instrument
(also called an option on a physical); and 3) an option contract on a futures contract
(also called a htures option).
Contract Month: the month in which delivery is to be made in accordance with a

futures contract.
Page 12A-8
Convertible: 1) a feature of an adjustable rate mortgage that permits a change to a

fixed rate mortgage. 2) a bond containing a provision that permits conversion to the
issuer’s common stock at some fixed exchange ratio.
Convexity: 1) a measure of the curvature of the relationship between the change in

bond price and the change in interest rates. A bond or note is said to have positive
convexity if the instrument’s value increases at least as much as duration predicts
when rates drop, and decreases less than duration predicts when rates rise. Positive
convexity is desirable to investors because it makes a position more valuable after an
interest rate change than suggested by a duration estimate. Negative convexity refers
to a position that loses value relative to duration’s prediction when prices change in
either direction. 2) a colloquial term for the gamma of an option, which practitioners
may refer to as curvature. Practitioners also may use interchangeably the terms
selling convexity and selling volatility; these terms refer to the pick up in yield for
selling the call options that are embedded in bonds such as MBS and callable GSE
bonds.
Corporate Bond Equivalent Yield: an upward adjustment to reflect monthly

payment of interest rather than semiannual payment of interest which is the
convention in the Corporate and Government bond markets.
Correspondent: a mortgage banker who services mortgage loans as a representative

or an agent for the mortgage owner or investor. Also applies to the mortgage
banker’s role as originator of mortgage loans for an investor.
Cost of Funds Index (COFI): an index that reflects the cost of funds for all thrift
institutions as reported by the Federal Home Loan Banks. Cost of funds is defined as
the annualized average interest paid or accrued on deposits, on FHLB advances and
other borrowed money during a reporting period. The most common COFI is the
Federal Home Loan Bank’s 1 lth District COFI, which is compiled from savings
banks in California, Arizona, and Nevada.
Counterparty: the opposite party to a financial transaction or contract.
Coupon: 1) the stated annual interest rate on a debt instrument that the issuer
promises to pay periodically to the holder until maturity. See “Coupon Rate”. 2) that
portion of the physical security which shows the interest due on the payable date
(usually semiannually). Physical securities may have detachable coupons that must
be presented by the holder for payment.
Coupon Date: the date the interest payment is due to the owner of the investment.
Coupon Income: the income received from the coupon rate on owned securities.
Coupon Rate: the interest rate on a debt instrument, expressed as a percentage of

face value, paid periodically by the issuer, e.g., a bond with a 6% coupon will pay $6
per $100 of face amount per year, usually in installments every six months. Not
synonymous with yield. See “Rate of Interest”.
Cover: purchasing to offset a short position. Same as “Short Covering”. See

“Offset”, “Liquidation”, “Evening Up”.
Covered Call Writer: a seller of a call option who owns the underlying security on
which the option is written.
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EXAMINER’S GUIDE
Cover Value: the monetary amount necessary to buy-in a short position at the
current market value.
Credit Enhancement: 1) the backing of a debt instrument with collateral, a bank

LOC, or some other device to achieve a higher rating for the debt instrument than
would be obtained based solely on the issuer’s credit risk. 2) any structural
component of a transaction that increases creditworthiness.
Credit Risk: the risk of default as reflected by the financial and operating risks of
the issuer.
Cross Hedge: a hedge with two transactions in different, but related, securities,
usually in different markets; e.g., a long position in US Treasury Bonds in the
futures market and a short position in the GNMA forward market.
Current Coupon: a newly issued or to-be-announced mortgage-backed security

selling at or close to par. Other new issues are referred to as discounts or premiums.
Current Issue: the most recently auctioned issue, usually in Treasury securities.
Also referred to as an on-the-run issue. Trading is more active in current issues than
in off-the-run issues.
Current Market Value: the closing price of a security as of the preceding business
day.
Current Maturity: current time to maturity on an outstanding note, bond, or other

money market instrument, e.g., a 5-year note one year after issue has a current
maturity of four years.
Current Yield: coupon payments on a security as a percentage of the security’s

market price. The market price should be gross of accrued interest, particularly on
instruments where no coupon is left to be paid until maturity. Often referred to as
current return.
Custodial Agreement: a contract in which a custodian agrees to exercise ordinary

care in safekeeping and administration of securities and financial instruments on
behalf of others. Regulation 703 prohibits a contract with a standard of care less than
ordinary. Modem term for Bailment for Hire.
Custodian: an individual or organization responsible for safeguarding and

administration of securities and financial instruments on behalf of others.
CUSIP Number (Committee on Uniform Securities Identification Procedures):

an identifying number assigned to a publicly-traded security. It is a nine-digit code
(alpha-numeric) that uniquely identifies an issue.
Dealer: any person engaged in the business of buying and selling securities for his
own account, through a broker or otherwise. Such an individual or firm is acting as
principal rather than as agent. The dealer typically does not charge a commission,
but makes a profit from the difference between its purchase price and its sale price.
A dealer is not required to disclose its cost basis. Therefore, each party to a trade
should establish whether the contra party will receive dealer status. The dealer’s
confirmation discloses to the customer that the dealer has acted as principal. At
different times, the same individual or firm may function as either broker dealer.
Page 12A-18
Dealers Association: see "Mortgage-Backed Securities Dealers Association".
Debenture: a bond secured only by the general credit of the issuer.
Debt securities: IOUs created through loan-type transactions-commercial paper,

bank CDs, bills, bonds, and other instruments.
Decay: the rate at which a variable's value diminishes through time, e.g., if a
variable is set equal to Ce-", and C is greater than 0, r is positive, and t equals time,
then the variable exhibits exponential decay. Where r is the continuously
compounded interest rate, the formula computes the present value of the cash flow
(C) that will occur at a time (t) in the future.
Deferred Futures: the most distant expirations of the listed futures contract months.
Also called back months.
Delay: refers to the "stated" delay time elapsed to the first payment of principal and
interest (GNMA I--45 days, GNMA 11-50 days, FHLMC PC--75 days, FHLMC
Gold--44 days, FNMA MBS-55 days, conventional pass-throughs-55 days). The
"actual" delay, or penalty, is 30 days less than the "stated" delay.
Deliverable Grades: see "Contract Grades".
Delivery: 1) the tender of the securities to the purchaser against receipt of payment
at the contract price in settlement of a cash or forward trade. 2) the tender and receipt
of the actual commodity, the cash value of the commodity, or of a delivery
instrument covering the commodity, e.g., warehouse receipts or shipping certificates,
used to settle a futures contract.
Delivery Month: a specified period (not necessarily a calendar month) within which
a futures contract can be settled by delivery.
Delivery Versus Payment (DVP): a security delivery method in which the buyer's
payment for securities is due at the time of delivery (usually to a bank acting as
agent for the buyer) upon receipt of the securities.
Delta: the expected change in an option's price for a given change in the price of the
underlying instrument or security.
Department of Housing and Urban Development (HUD): a department of the US

Government. GNMA is a corporate instrumentality within HUD.
Deposit Note: a term deposit in a bank. A deposit note is an obligation of a bank that
is similar to a certificate of deposit but is rated.
Depository: a central facility for holding securities which enables securities

transactions to be processed by book entry without physical delivery of securities
certificates. In addition to safekeeping, a depository may incorporate comparison,
clearing and settlement functions. Major depositories include the Depository Trust
Company (DTC) and the Fedwire book-entry securities system. DTC has a separate
MBS Division (formerly operating as the Participants Trust Company).
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Discount: an amount, expressed as a percentage or dollar amount, that a security is

trading below its par value. Some securities, e.g., Treasury Bills, are issued at a
discount, without a coupon, and are redeemable at par when they reach maturity; the
difference between the original discount and par provides the rate of return on the
investment.
Discount Bond: a bond selling below par.
Discounted Cash Flow: an accounting technique used to estimate the present value
of future cash flows by applying a discount rate to anticipated cash flows.
Discount Rate: 1) the interest rate charged by the Federal Reserve Banks for loans
to member banks, using government securities or eligible paper as collateral. 2 ) a
discount rate (as opposed to the Discount Rate) is an interest rate used in
determining the present value of future cash flows.
Disintermediation: the phenomenon that occurs when there is a decline in the

deposit and lending relationships between financial intermediaries and their
customers and an increase in direct relationships between ultimate suppliers of funds
and ultimate borrowers of funds. Caused, for example, when financial intermediaries
cannot compete efficiently with the rates being paid by others. This results in a
shrinkage in the amount of deposits held by those financial intermediaries which are
unable to pay the higher (market) rates. See also “Intermediation”.
Dollar Rolls: a special repurchase agreement transaction where the holder of a

security agrees to sell the security to a second party and agrees to buy back a security
with substantially similar characteristics at a specified price, on a specified date. It
differs from a repurchase transaction in that the seller gives up the cash flows from
the security during the roll period. The accounting profession may refer to this type
of transaction as a Dollar Price Repurchase Agreement.
Domino Effect: the notion that a default by (or financial stress at) one organization
will cause a default or financial stress at other firms in the securities industry because
of interconnected obligations.
Don’t Know (DK): denying knowledge of a trade and a refusal to settle a trade by a
buyer when the buyer (or the buyer’s receiving agent) does not recognize
confirmation or the securities that the seller has delivered. The buyer’s operations
department may have no record of or instructions to complete the trade, or the buyer
may “DK” the trade because it reflects an incorrect price or quantity.
Due Bill: a promissory note delivered in lieu of the security to a buyer by the seller
which evidences the seller’s obligation to deliver the security to the buyer at a later
date. A due bill check is a post-dated check issued by the seller to the buyer that
becomes payable to the buyer on a specified date in the amount of principal and
interest due to the buyer. Prior to the payable date, the due bill check serves as a due
bill.
Duration: a measure of the sensitivity of an instrument’s price to changes in yields.

It is calculated as a present value-weighted time to maturity of the cash flows from
an instrument. Also termed “Macaulay Duration”. See also “Modified Duration”,
which is slightly different but often used interchangeably with duration. For a bond
with known cash flows, the percentage change in the security’s price in response to a
small change in yield is approximately equal to the negative of the product of the
Page 12A-12
security’s modified duration and the rate shift. For mortgage-backed securities, such
as CMOS, where cash flows are subject to uncertainty, the calculated duration is a
poor indication of market risk, since it does not adjust for the impact of changing
interest rates on prepayment and extension risks. In such a case “Effective
Duration” is a better measure.
Effective Duration: a measure of the sensitivity of an instrument’s price to changes

in yields, taking into account the effect of embedded options and changes in
prepayments. It is calculated typically as an average percentage change in a bond’s
value (price plus accrued interest) for shifts in the Treasury curve of +/- 100 basis
points (that is, plus and minus one percent). Effective duration may also be
calculated for other shifts ( e g , +/- 200 basis points) in the Treasury curve.
Embedded Option: an option that is an inseparable part of another instrument.

Embedded options include caps, floors, calls, puts, and prepayment provisions.
Typical embedded options grant early termination rights to the issuer, such as the
call provision in many corporate bonds or the homeowner’s prepayment option that
permits the issuer to repay the mortgage-backed security earlier than the nominal
maturity. While embedded options are not severable, in contrast, detachable options
can be traded separately.
Endorsement: a signature, other than that of a signer as maker, drawer, or acceptor,

that alone or accompanied by other words is made on an instrument for the purpose
of 1) negotiating the instrument, 2) restricting payment of the instrument, or
3) incurring endorser’s liability on the instrument. Spelled “ indorsement” in the
Uniform Commercial Code.
Equivalent Bond Yield: annual yield on a short-term, non-interest-bearing security

calculated so as to be comparable to yields quoted on coupon securities. See “Bond-
Equivalent Yield”.
Escrow Agent: a third party, acting as an agent for the buyer and the seller, who
carries out the instruction of both and assumes the responsibilities of handling the
paperwork and the disbursement of funds.
Escrow Fees: fees charged by the escrow holder for services.
Eurodollars: U S . dollars deposited in a financial institution located outside of the

United States. Permissible Eurodollar deposits under Part 703 are deposits in foreign
branches of United States depository institutions. These deposits are not covered by
FDIC insurance.
Evening Up: buying or selling to offset an existing market position. See

“Liquidation”.
Exchange: an organization which maintains a market by bringing together members

to execute trades in the commodities or securities listed on the exchange. Also called
a “Board of Trade” in the commodities markets.
Exchange of Cash for Futures: a transaction in which the buyer of a cash

commodity receives a short futures position in a corresponding amount and the seller
of a cash commodity receives a long futures position in a corresponding amount, at a
price difference from the cash commodity mutually agreed upon. These transactions
allow ex-pit trading of fitures to facilitate movement of the cash commodity and can
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establish, transfer, or offset open interest. Also called Exchange for Physical, or
Against Actuals.
Exempted Securities: securities exempt from registration under the Securities Act
of 1933 (see section 3) or exempt from certain provisions of the Securities Exchange
Act of 1934 (see section 3(a)( 12)). Such securities include governments, agencies,
municipal securities, and certain commercial paper and private placements.
Exercise: to elect to put into effect the right (but not the obligation) held by an
option holder, e.g., to require the option writer to deliver a security at the strike price
(call), or to require the option writer to purchase a security at the strike price (put).
Exercise Price: the price at which the option buyer may purchase (call) or sell (put)
the underlying security. Also called “Strike Price”.
Expiration Date: the final date on or before which an option may be exercised. If
not exercised by the expiration date, the option is void and worthless.
Extension Risk: the potential that the principal of a mortgage-backed security will
be paid later than expected, typically in response to rising interest rates. Since the
expected prepayments will be slower in a higher interest rate environment, the result
is a longer expected average life. Opposite of “Prepayment Risk”.
Face Value: typically the value of a bond or financial instrument at maturity.

Historically, all securities were issued in the physical form of a certificate; the face
value appeared on the face of the certificate. Face value is not an indication of
market value. For amortizing instruments such as mortgage-backed securities, face
value typically refers to the original principal amount. Also called “Par Value”.
Factor: the proportion of the outstanding principal balance of a security to its

original principal balance expressed as a decimal. In mortgage backed securities
(MBS), the principal amount of each outstanding certificate is reduced monthly by
its pro rata share of the regular mortgage payments by the mortgagees of the
underlying mortgages and any prepayments or foreclosures. The MBS issuer
publishes a list of factors each month (e.g., .98765432 1). The MBS security holder
can calculate the current amount of principal outstanding by multiplying the factor
by the original principal amount (e.g..98765432 1 factor times $100,000 original
principal balance = $98,765 outstanding principal balance). The MBS security
holder can calculate the amount of principal received in the current month by
subtracting the prior month’s outstanding principal balance from the current month’s
outstanding principal balance.
Fail: when the seller of a security does not make delivery on the agreed settlement
date.
Fair Value: the amount at which an instrument could be exchanged in a current

arms-length transaction between willing parties, other than in a forced liquidation
sale. Market prices, if available, are the best evidence of the fair value of financial
instruments. If market prices are not available, the best estimate of fair value may be
based on the quoted market price of a financial instrument with similar
characteristics or on valuation techniques (e.g., the present value of estimated future
cash flows using a discount rate commensurate with the risks involved, option
pricing models, or matrix pricing models.)
Page 12A-14
Fannie Mae: see “Federal National Mortgage Association (FNMA)”.
Farmers Home Administration (FmHA): a US Government agency established

under the Farmers Home Administration Act of 1946 to provide financing to farmers
and other qualified borrowers who are unable to obtain loans elsewhere. It makes,
participates in, and insures loans for rural housing and other purposes.
Federal Agency Security: interest bearing debt securities issued by U.S.

departments and agencies. Agency securities are backed by the full faith and credit
of the U.S. government (e.g., GNMA pass throughs and participation certificates).
Securities of Government Sponsored Enterprises (GSEs) often are referred to as
agency securities, but typically are backed only by the issuer (e.g., FNMA
debentures).
Federal Funds (Fed Funds): funds deposited at Federal Reserve Banks by financial
institutions, including funds in excess of reserve requirements. Fed funds can be sold
by a credit union to a Section 107(8) institution. Fed funds sold represents an
uninsured investment by the credit union (a permitted borrowing by the bank).
Although a credit union can also buy Fed funds, Fed funds purchased represents a
borrowing by the credit union.
Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac): a

private corporation authorized by Congress. FHLMC is a secondary-market facility
of the FHLBB system. It primarily sells mortgage participation certificates secured
by pools of conventional mortgage loans whose principal and interest are guaranteed
through the FHLMC.
Federal Housing Administration (FHA): a division of HUD. Its main activity is

the insuring of residential mortgage loans made by private lenders. It sets standards
for construction and underwriting. FHA does not lend money or construct housing.
Federal National Mortgage Association (FNMA or Fannie Mae): a private

corporate created by Congress to support the secondary mortgage market. It
primarily purchases conventional residential mortgages and issues mortgage-backed
securities.
Federal Open Market Committee (FOMC): the arm of the Federal Reserve
System (Fed) that controls the purchase and sale of securities in the market for the
Fed’s open market account. A purchase of securities by the Fed adds reserves to the
banking system (increasing the money supply), while a sale of securities withdraws
reserves. Open market operations serve as one of three basic tools the Fed uses to
conduct monetary policy (the other two being changes in the discount rate and
reserve requirements).
Fee: 1) a Commitment Fee is a payment to investors or prospective investors, which

may or may not be refundable, for the purpose of obtaining a commitment to
purchase or to sell securities. 2) a Standby Fee is a non refundable amount received
or paid for the sale or purchase of a standby commitment. 3) an Up-front Fee is a
commitment fee paid in advance of the settlement date to an investor for a future
purchase.
Fee Trading: see “Adjusted Trading”
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FHA Experience: a statistical series, revised periodically, which represents the

portion of mortgages that “survive”a given number of years from their origination.
Financial Accounting Standards Board (FASB): the professional quasi-regulatory

organization that primarily establishes and reviews generally accepted accounting
principles (GAAP), which are mainly delineated by Statements of Financial
Accounting Standards (SFAS).
Financial Instruments: 1) any obligation or contract which can be negotiated,

including stocks, bonds, commercial paper, forwards, and futures. 2) more generally,
cash, evidence of an ownership interest in an equity, or a contract that establishes a
right of one party to receive cash (or another financial instrument or to exchange
other financial instruments on potentially favorable terms with the counterparty.
Financial Intermediary: a financial institution which acts as an intermediary

between savers and borrowers by accepting money from the public and, in turn, by
lending the accumulated funds to borrowers. The classification includes savings
associations, commercial banks, mutual savings banks, life insurance companies, and
credit unions.
Firm Commitment: a commitment to buy or sell a security at a fixed price for a

specified period of time.
Firm Price: a price at which a trader is willing to trade for a limited period of time,
usually no longer than the length of the phone call. Opposite of indicative price or
indication.
Floor: 1) an embedded option in a floating-rate security that places a rate minimum

(specifying the lowest interest rate that will be paid) on the floating rate coupon. 2 ) a
stand-alone option contract (usually written as a swap) that pays the holder of the
floor an amount equal to the notional principal amount times the excess of the floor
rate over the market rate. A floor usually consists of a strip of caplets, i.e., a series of
options with sequential expiration dates. Each caplet is an option on rates for a single
period of time.
Floor Broker: any person who, in or surrounding any pit, ring, post or other place
provided by an exchange for the meeting of persons similarly engaged, executes for
others any orders for the purchase or the sale of any commodity or security and
receives a prescribed fee or commission.
Foreclosure Payment: a prepayment made to holders of mortgage-backed securities

from proceeds of property liquidation after foreclosure. Amount of prepayment must
equal the principal balance of the foreclosed mortgage.
Forward: a cash market transaction in which two parties agree to the purchase and
the sale of a commodity at some future time under such conditions as the two agree.
In contrast to futures contracts, the terms of forward contracts are not standardized.
A forward contract usually is not transferable and can be canceled only with the
consent of the other party, which often must be obtained for consideration and under
penalty, and forward contracts are not traded in federally designated contract
markets. Essentially, forward contract refers to any cash market purchase or sale
agreement for which delivery is not made ”on the spot.” See “Commitment”, “Cash
Forward Agreement”, and “Standby Commitment”.
Page 12A-16
Forward Contract: see “Forward”.
Forward Market: refers to informal (non exchange) trading of commodities to be

delivered at a future date. Contracts for forward delivery are not standardized, e.g.,
delivery time and amount are as determined between seller and customer.
Forward Months: see “Deferred Futures”.
Forward Roll: like “roll over,” a term used to describe the action of selling an
investment position and redeploying the proceeds into a new but similar position. A
trader in the Government securities market may elect to sell a long position in the
previously-issued 2-year note (the “current” 2-year) and use the proceeds to buy the
newly-issued 2-year note (referred to as the “when issued“ or “w.i.“ 2-year) prior to
its settlement date. When this action is done with the forward settlement date, it is
described as a “forward roll from the current to the w.i.” In the futures and options
markets, a forward roll is used to describe the extension of a position from one
month (maturity) to a longer month. A trader may elect to shift from a March
Eurodollar contract to a June Eurodollar contract to avoid the expiration date on the
March contract.
Freddie Mac: see “Federal Home Loan Mortgage Corporation (FHLMC)” .
Fully Modified Pass-Through: a security for which the timely payment of both
principal and interest is guaranteed. Investors in the security will receive mortgage
interest and principal payments on a certain date regardless of whether the mortgage
borrowers have actually made those payments.
Funding Date: term used by mortgage bankers to denote the date on which the
mortgage banker funds or finances a new issue of MBS. See “Settlement Date”.
Fungibility: the characteristic of interchangeability. Treasury securities of the same

maturity and coupon are interchangeable, as entries in the Fed’s book-entry system.
Futures contracts for the same commodity and delivery month are fungible due to
their standardized specifications for quality, quantity, delivery date, and delivery
locations. GNMAs bearing the same interest rate generally are treated as fungible
until pool numbers are assigned. Subsequently, fungibility may decline or vanish.
Futures Commission Merchant: the CFTC’s term for a futures broker. Any
individual, association, partnership, corporation, or trust engaging in soliciting or in
accepting orders for the purchase or sale of any commodity for future delivery on, or
subject to, the rules of any futures exchange.
Futures Contract: an agreement to purchase or sell a commodity or financial

instrument for delivery in the future: at a price determined at initiation of the
contract, which obligates each party to the contract to fulfill the contract at the
specified price, which is used to assume or shift price risk, and which may be
satisfied by delivery or offset. Futures contracts are sold on an exchange or board of
trade in which the terms are standardized. See “Contract Market”.
Futures Exchange: see “Contract Market’’.
Futures Price: the price of a given commodity unit determined by public auction on
a futures exchange.
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Gamma: a measure of the rate of change of the option’s delta with respect to a
change in the price of the underlying asset.
Gap: mismatch between the earlier of maturity or repricing of a depository

institution’s assets and liabilities, prepared by scheduling the cash flows of all
balance sheet items into time periods, or “buckets.” A static gap reports the current
balance sheet repricing mismatch. Dynamic gap a) typically refers to a gap report
projected as of a future balance sheet date, but b) may refer to the use of estimated
cash flows in the maturity or repricing buckets of a gap report.
General Obligation Bonds: municipal securities secured by the issuer’s pledge of

its full faith, credit, and taxing power.
Ginnie Mae Mortgage-Backed Security (Ginnie Mae or GNMA): a security

issued and guaranteed by the U.S. Government. Cash flows on Ginnie Mae securities
are based on the underlying FHA, VA, or FmHA mortgages. The term “pass-
throughs” is often used to describe Ginnie Maes. See “Government National
Mortgage Association”, “GNMA I”, “GNMA II”.
GNMA I: a pass-through mortgage-backed security on which the registered holders

receive on the 15th day of each month a separate principal and interest payment on
each of their certificates. GNMA I securities are collateralized by a pool of
mortgages from a single originator, such as a mortgage banker, commercial bank,
savings and loan association, savings bank, credit union, or and other institution.
GNMA 11: a pass-through mortgage-backed security on which registered holders

receive on the 20th day of each month an aggregate principal and interest payment
from a central paying agent on all of their GNMA I1 certificates. GNMA I1 securities
are collateralized by multiple-issuer pools (“Jumbos”) or custom pools (one
originator but different interest rates that may vary within one percentage point).
Go-Around: the technique whereby the manager of the System Open Market
Account purchases and sells securities for the Federal Reserve System.
Good Delivery: a term indicating that a security in proper form has been delivered
timely in accordance with the terms of the transaction.
Government Agency: organizations established by Congress to serve many

different purposes. Most agencies typically do not issue securities, but borrow
indirectly through the US Treasury. Those securities issued directly by agencies
typically are direct obligations of the US Government. Government Sponsored
Enterprises, which are private corporations, often are called (loosely and
erroneously) “agencies”.
Government National Mortgage Association (GNMA or Ginnie Mae): a wholly-

owned government corporation within the Department of Housing and Urban
Development. GNMA supports a secondary market in government insured and
guaranteed mortgages. GNMA securities are backed by pools of FHA-insured and
VA-guaranteed mortgages. See “ Ginnie Mae”, “ GNMA I” , ‘‘ GNMA 11” .
Government Sponsored Enterprise (GSEs): a financial intermediary established

by Congress to provide funding to sectors of the economy that are in need of credit
beyond that supplied by purely private intermediaries. GSEs are privately owned and
operate with limited government direction. Obligations are not guaranteed by the full
Page 12A-18
GLOSSARY OF INVESTMENT TERMS APPENDIX 12A -’
faith and credit of the U.S. government. Examples include:

.Federal Home Loan Bank (FHLB)
.Federal Home Loan Mortgage Corporation (FHLMC - Freddie Mac)
.Farm Credit System
.Agriculture Mortgage Corporation (Farmer Mac)
.Student Loan Marketing Association (SLMA - Sallie Mae)
.Financing Corporation (FICO)
Graduated Payment Mortgage (GPM): a mortgage that features negative

amortization in which early payments are scheduled to be insufficient to pay the
interest accruing on the outstanding principal. After a period of low initial payments,
there is a graduation period where the size of the payments increase for some
number of years. The number, frequency, and rate of increases are specified in the
original contract.
Gross Long: the total of open long (purchase) contracts, not reduced by any short
positions (sales contracts) held at the same time.
Gross Short: the total of open short (sales) contracts, not reduced by any long
positions (purchase contracts) held at the same time.
Guaranteed Loan Participation Certificate (GLPC): see “Small Business

Administration Secondary Participation”.
Guaranty: a promise by one party to pay a debt or to perform an obligation

contracted by another party in the event that the original obligor fails to pay or
perform as contracted.
Haircut: 1) deductions of specified percentages from the market value of assets

solely for the purpose of computing regulatory net capital. 2) in computing the worth
of assets deposited as collateral or margin, the difference between the actual market
value of a security and the value assessed by the lending side of a transaction.
Hedge: 1) a position or combination of positions that reduces some type of risk,

usually at the expense of expected return. A hedging transaction is a transaction or
position in a swap, futures contract, or other financial instrument that reduces
financial risks of a commercial enterprise. Typical hedges involve: entering into an
opposite position (in a related security in the cash market or in a futures contract) to
a position held in the cash market to minimize the risk from adverse price changes;
and entering into a position in the futures market as a temporary substitute for a cash
transaction that will occur later to guarantee today’s price. 2 ) among traders and
portfolio managers, a term used to describe a partially hedged position. 3) used
erroneously to minimize the perceived risk in describing a risky position (or
combination of positions) taken with the intent of profiting from an expected change
in a spread (also termed a basis arbitrage) or value (also termed a risk arbitrage).
Hit: a dealer is “hit” when the bid side of a market which the dealer has made is
accepted by the customer, that is, when the customer sells a security to the dealer.
When bids are being “hit,” the general response of the dealer is to lower the bid
price.
HUD: the Department of Housing and IJrban Development. Established by the

Mousing and Urban Development Act of 1965 to supersede the Housing and Home
Finance Agency. Responsible for the implementation and administration of
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EXAMINER’S GUIDE
government housing and urban development programs. HUD programs include

community planning and development, housing production, the extension of
mortgage credit (FHA), and ensuring equal opportunity in housing.
Impound: see “Escrow Payment”.
Indenture of a Bond: a legal statement spelling out the obligations of the bond
issuer and the rights of the bondholder.
Index: the interest rate used in determining the coupon rate of a variable rate
security or loan. A margin is usually added to the index.
Index Amortizing Note (IAN): a note that returns principal prior to final maturity.
The amount and timing of the return of principal is linked to an index, such as three-
month LIBOR or the prepayment speed of a mortgage-backed security. Typically, as
the index rises, the scheduled return of principal payments slow down, exposing the
owner to extension risk; as the index declines, the scheduled return of principal
payments increase, exposing the owner to prepayment and reinvestment risk.
Corporate credit unions have offered Amortizing Certificate Programs (ACPs) that
behave in a similar manner. IANs are not mortgage backed, but they have similar
market risk due to the uncertainty of payments.
Initial Margin: the amount of money or its equivalent that a customer must deposit
with a broker when the customer buys or sells a security or futures contract on
margin.
Institutional Lender: a financial institution that invests in mortgages and carries

them in its own portfolio, e.g., mutual savings banks, life insurance companies,
commercial banks, pension and trust funds, and savings and loan associations.
Insured Association: a savings association with savings accounts insured by FDIC.
Interest Rate Risk: the potential for change in the value of a security when the level
of interest rates changes.
Interest Rate Swap: a contract to exchange streams of interest payments, e.g. fixed
for floating, based upon a specified dollar amount (notional amount) at specified
dates in the future.
Interest Trades: these transactions involve a) a purchase of securities for current

settlement; b) a delayed settlement (forward) sale of these securities or the
possession of a long standby; and c) a financing of a long position by a sale under an
agreement to repurchase on or before the forward delivery date.
Intermediation: the phenomenon that occurs when rates paid by certain financial
intermediaries can compete successfully with the rates being paid by others, e.g., the
US Government on its Treasury Bills. ‘Thiscauses an expansion in the amount of
deposits held by the intermediaries which are able to pay higher rates. See
“Disintermediation”.
In-the-Money: a term to describe an option that has a positive value if exercised

immediately. A call option is in-the-money if the underlying security’s price is
higher than the option’s strike price. A put option is in-the-money if the underlying
Page 12A-20
security’s price is below the option’s strike price. An option that is in-the-money has
intrinsic value.
Intrinsic Value: the value of an option if immediately exercised. A call option has
intrinsic value when the price of the underlying security exceeds the option’s
exercise price. A put option has intrinsic value when the underlying security’s price
is less than the option’s exercise price.
Inventory: the total issues, long and short, held by a dealer that comprise that
dealer’s inventory.
Inverted Market: a futures market in which the nearer months are selling at prices
higher than the more distant months; hence, a market displaying inverse carrying
charges. This is characteristic of markets in which supplies are currently in shortage.
Inverted Yield Curve: a graph illustrating the level of interest rates as a function of
time to maturity, where shorter maturity investments have higher yields than longer
maturity investments. Inverted Yield Curves generally occur during period when the
Federal Reserve is attempting to fight inflation by restraining growth in economic
activity and restricting growth in the money supply. Normally, the yield curve is
upward slopping.
Issuer: the legal entity that is selling or has sold its security or other financial
instrument. In mortgage banking, the entity who pools mortgages to back GNMA
pass-through securities. See “ Originator” .
Junior/Senior Structure: a securities issuance with one class that is subordinated to

a senior obligation.
J u n k Bond: a bond with a credit rating that is low, below BBB (S&P) or equivalent.
Key Rate Duration: a duration analysis technique to determine the affect on an

instrument’s value of a rate change in part of the yield curve. The sum of the key
rate durations for an investment provides a measure comparable to duration for
parallel shifts in the yield curve.
Legal Eligibility: investments that life insurance companies, mutual savings banks,
or other regulated investors may make under a state charter, law, or regulation.
Liquidation: 1) making a transaction that offsets or closes out a position. 2) closing

out a defaulted transaction.
Liquidity Risk: 1) the potential loss when a security cannot be sold promptly at or
near prevailing market prices. This may be the result of a general market disruption,
uncertainty in the market place regarding the value of the security, or a large position
relative to market trading volume. 2) in a financial institution, the costs incurred to
attract new deposits or liquidate assets to meet the cash flow needs of unanticipated
withdrawals.
Liquidity Support: in a structured securities transaction, a source of funds for the

issuing trust to cover shortfalls in cash flow resulting from timing mismatches
between payments received on trust assets and payments due to securities holders.
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Load Fee: a fee charged to invest in a mutual fund. Load fees may be “up-fiont“
fees charged at the time of purchase andor ‘‘back-door“or “back-end“ fees charged
at the time of sale. These fees may be based on the amount of funds placed in the
investment and the length of time the investment is held.
Long Bond: generally a bond that matures in more than ten years is a long bond.
Wall Street refers to the 30-year U.S. Treasury bond as the “ long bond.”
LIBOR: the London Interbank Offered Rate. When not specified, usually the rate at
which major banks offer to lend US dollars (i.e., to make a Eurodollar deposit, as
opposed to a deposit denominated in some other currency such as the German mark).
There is a different LIBOR rate quoted for each deposit maturity. Different banks
may quote slightly different LIBOR rates, just as different banks in the US may have
slightly different deposit rates. A popular interest rate survey of LIBOR is prepared
each day by the British Bankers’ Association (BBA). NCUA considers a US dollar-
denominated LIBOR to be a domestic interest rate.
Long: one who owns an inventory of securities, commodities, or forward or futures

contracts.
Long the Basis: a person or firm that has bought the spot commodity and hedged
with a sale of futures is said to be long the basis.
Macaulay Duration: see “Duration”
Maintenance Margin: the minimum amount of money or collateral required to be

maintained in a margin account in accordance with exchange regulations or broker
requirements. If a customer’s margin account drops below the required level, the
broker issues a margin call to the customer for a payment sufficient to restore the
account, often to the level of the initial margin. Maintenance Margin differs from
Variation Margin or Payment, which is a cash payment made to the clearinghouse,
usually at least daily, because of an adverse movement in price.
Maker: see “Writer”.
Making a Market: a dealer makes a market when he stands ready to buy or sell at
his bid and offered prices.
Margin: 1) a constant value added to an index to arrive at the fully indexed coupon,
which is the interest rate paid on a variable rate loan or investment, in the absence of
a teaser rate or binding cap rate. The cap rate will be paid on an investment while its
fully indexed coupon is above the cap rate. 2) a deposit of cash or collateral by a
client with a broker (or by a broker with a clearing house) which protects the broker
(or clearing house). Margin in commodities is not a payment for equity or down
payment on the commodity itself, but rather is in the nature of a performance bond.
The difference is significant because a) both buyers and sellers post margin in
commodities; b) the remainder of the position is not being borrowed from one‘s
broker and does not require interest payments; and c) as price moves against one’s
position, the account is debited (termed Variation Margin at the clearing member
level) and the protection represented by the Initial Margin may fall below the
prescribed maintenance level, in which case the trader will be required to post
additional margin. See “Initial Margin”, “Maintenance Margin”, “Original
Margin”, and “Variation Margin”.
Page 12A-22
Margin Call: 1 ) a call from a brokerage firm to a customer to bring margin deposits
up to minimum levels required by the broker, at least equal to exchange minimums.
2) a request by the clearing house to a clearing member to bring clearing margins
back to minimum levels required by the clearing house rules.
Market Order: an order to buy or to sell a stated amount of a security at the most
advantageous price obtainable after the order is entered.
Market Price: market price usually is indicated by the last reported price at which
the security or financial instrument sold. For an inactive security that has not traded
recently, the market price is the latest bid price.
Market Risk: the risk that an investment will vary in price as market conditions
change.
Market Value: the current or prevailing price of a security, at which a security

presumably could be sold.
Marketability: 1) the capacity of the market in a particular security to absorb a

reasonable amount of buying and of selling at reasonable price changes. See
“Liquidity Risk”. 2) the degree of investment interest underlying a security.
Mark-to-Market: 1 ) to value a position or portfolio at current market prices.

Marking to market is an effective way to monitor profit and loss. Trading accounts
must be marked to market daily to provide management with a measure for control
purposes. 2) a procedure whereby a brokerage concern has the right to demand funds
or securities in the amount of unrealized loss on unsettled contracts to purchase or
sell securities. The making of a mark to market payment restores original margin.
3) the accounting adjustment made to bring the book value of an investment to its
market value. It is the accounting procedure that is applicable to a credit union’s
trading account securities.
Markup: the difference between what a dealer has paid for a security and the price
at which the security is offered to another person. May be referred to loosely as
Spread. Spread, however, usually refers to the difference in current bid and current
offer prices, rather than the difference between the dealers cost and the current offer
price.
Matched Repurchase Agreement (Matched REPO): matched repurchase

agreements include transactions in which a dealer acquires a security on a reverse
repurchase agreement or a collateral loan, only when the dealer has outstanding
commitments both to repurchase and to resell the security on the same date. If the
reverse repurchase agreement is made first in anticipation of a subsequent matching
agreement, the transaction is not a matched agreement until the security is sold under
a repurchase agreement. Matched agreements also include transactions in which a
dealer is in any way subject to a contingent liability, as well as those where the
dealer is acting as an agent in a transaction that involves the temporary exchange of
cash for securities between two or more other parties but remains contingently liable
for any losses incurred because of the failure of any of the other parties to fulfill
their part of the agreement.
Matched Sale-Purchase Agreements: an agreement where the Federal Reserve

sells a security outright for immediate delivery to a dealer or foreign central bank,
with an agreement to buy the security back on a specific date (usually within seven
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EXAMINER’S GUIDE
days). Matched Sale-Purchase Agreements are the reverse of repurchase agreements

and allow the Federal Reserve to withdraw reserves on a temporary basis.
Maturity: the date on which the principal amount of the security is due and payable
to the registered owner of the security. On such date, the accrual of interest typically
terminates on a note, time draft, acceptance, bill of exchange, mortgage-backed
security, or bond.
Medium-Term Notes (MTNs): plain corporate debt instruments with a fixed rate
and fixed maturity (typically less than seven years), that often are continuously
offered notes, ranging in maturity from nine months to 30 years. Bank Deposit Notes
are a form of MTN.
Midgets: GNMA pass-through security with collateral of 15-year original maturity

mortgages. It is similar in structure to a GNMA security backed by 30-year original
maturity mortgages.
Modified Duration: a measure of the sensitivity of an instrument’s price to changes

in yields. It is calculated as Duration, discounted by a small factor noted below. See
“Duration”. Modified Duration often is used interchangeably with Duration, since
many uses of duration are not sensitive to the small difference. For a bond with
known cash flows, the percentage change in the security’s price in response to a
small change in yield is approximately equal to the negative of the product of the
security’s modified duration and the rate shift. For mortgage-backed securities, such
as CMOSwhere cash flows are subject to uncertainty, the calculated duration is a
poor indicator of market risk, since it does not adjust for the impact of changing
interest rates on prepayment and extension risks. In such a case Effective Duration is
a better measure.
where Dmod=modified duration; y= yield to maturity; f= frequency of

coupon payment, and D = duration.
Modified Pass-Through: a security for which the timely payment of interest, but
not principal, has been guaranteed by an institution or agency.
Money Market: the market for trading of short-term, high-grade financial

instruments, such as banker’s acceptances, certificates of deposit, and commercial
paper.
Money Market Mutual Fund: a mutual fund that invests in highly liquid securities
and pays money market rates of interest, in accordance with regulations of the SEC
(17 CFR 240.2a-7). Some funds invest only in government-backed securities.
Money market funds attempt to maintain a stable Net Asset Value (NAV) of $1 .OO
per share. These funds are not insured by the government.
Mortgage-Backed Security Dealers’ Association: a voluntary association of

dealers in GNMA mortgage-backed securities. The association changed its name
from the GNMA Mortgage-Backed Securities Dealers’ Association.
Mortgage Banker: a party who originates, sells, and services mortgages. A

mortgage banker retains servicing rights to loans and may service the loans it has
sold. A mortgage banker also may sell servicing rights. As the local representative of
Page 12A-24
regional or national institutional lenders, it acts as a correspondent between lenders

and borrowers.
Mortgage Bankers Association of America (MBA): an association of mortgage

bankers. The association serves as the trade association for the mortgage banking
industry.
Mortgage Bond: a bond secured by a lien on property, equipment, or other real

assets.
Mortgage-Backed Bonds: a bond collateralized by mortgages. The cash flow of the

bond need not be linked directly to the principal payments of the mortgages.
Mortgage-Backed Security: a term used broadly to refer to a security backed by

mortgages, including pass-through securities, pools, mortgage-backed bonds, and
CMOS.
Mortgage Pass-Though Security: a security representing an undivided ownership

interest in a pool of mortgages. The mortgages are serviced by a financial institution
which transfers the monthly payments by home owners of principal and interest (less
a servicing fee and a guarantee fee, if any) to be received by the owner of the interest
in the MBS. This process of transferring cash flow is termed a “pass through.”
Mortgage Participation Certificates: similar to pass-through securities,

representing an undivided interest in residential mortgages.
Mortgage Yield: an internal rate of return calculation. In the early days of

mortgage-backed securities, the yield was calculated as if all principal were prepaid
at the end of 12 years. Now, a reasonable and supportable estimate of the
prepayment speed is used in calculating the estimated yield on a mortgage-backed
security. See “Constant Prepayment Rate”.
Municipal Securities Rulemaking Board (MSRB): a self regulatory organization

established to propose and adopt rules for brokers and dealers in Municipal
Securities. The SEC oversees the MSRB. The MSRB was created under gl5B of the
Securities Exchange Act of 1934.
Municipal Security (Muni): obligations of a state, and of a county, city, tax district,
or other division of a state. Municipal securities include: a) General Obligation (GO)
Bonds, which the municipality backs with its full faith and credit; b) Revenue
Bonds, which are payable from specified revenues only, such as a property or
facility financed by the revenue bond, but which do not bind the municipality; and c)
short term notes issued by municipalities in anticipation of tax receipts (tax
anticipation notes or TANS),proceeds from a bond issue (bond anticipation notes or
BANS), or other revenues (revenue anticipation notes or RANs). Many municipal
bonds are insured by municipal bond insurance typically issued by one of three
leading triple-A rated municipal-bond insurers, AMBAC Indemnity corporation,
FGIC (Financial Guarantee Insurance Corporation, or MBIA (Municipal Bond
Insurance Association).
Mutual Fund: a fund operated by an investment company that raises money from
shareholders. Funds offer professional management and diversification for a fee. The
market price of a share is called its Net Asset Value (NAV), which reflects the mark-
to-market value of all securities held by the investment company. Also called open
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end investment company. A mutual fund that invests in fixed income securities often
is called a bond fund. See “Money Market Mutual Fund”.
National Association of Securities Dealers, Inc. (NASD): the self-regulatory

organization of the securities industry responsible for regulation of the Over-The-
Counter securities market and the many products traded in it. The NASD administers
qualifications tests to securities professionals and enforces compliance by its
members with the securities laws, the rules of the Municipal Securities Rulemaking
Board, and NASD rules. The NASD rules, in general, protect investors by
preventing fraudulent and manipulative acts and practices, and promoting just and
equitable principles of trade. The NASD was created under 0 15A of the Securities
Exchange Act of 1934 (the Maloney Act). The SEC oversees the activities of the
NASD. The NASD also owns and operates the NASDAQ market.
Negative Arbitrage: See “Arbitrage”.
Negative (or Inverse) Yield Curve: See “Inverted Yield Curve”.
Negotiable Security: under the Uniform Commercial Code (UCC), an instrument

that meets certain legal requirements and can be transferred by endorsement or
delivery.
Net Asset Value: the value of a mutual fund share determined by the fund on a daily
basis based upon the market value of the underlying securities and the number of
shares outstanding.
Net Capital: net worth of a brokerage concern, less certain items such as exchange
memberships, carrying value of securities which are not readily marketable,
“haircuts” on marketable securities in proprietary accounts, furniture and equipment,
etc.
Net Long: a net position that is long.
Net Position: the difference between the open long contracts and open short
contracts held by one trader in any one contract market or financial instrument.
Trades which have been offset are removed from the net position.
Net Short: a net position that is short.
Net Yield: the part of gross yield that remains after the deduction of all costs, such
as mortgage servicing expenses and guaranty fees. See also “Yield”.
New Issue: 1) a security that is purchased at issuance. 2) a recently issued security.
No Load: a mutual fund sold without a load fee.
Normal Yield Curve: a graph illustrating the level of interest rates as a function of
time to maturity, where shorter-maturity investments have lower yields than longer-
maturity investments. The Normal Yield Curve is upward slopping.
Note: a written promise to pay a debt.
Notional Principal (or Notional Amount): in an interest rate swap agreement, the
dollar amount to which interest rates are applied in order to calculate periodic
Page 12A-26
payment obligations. The notional amount is not exchanged by the parties to the
interest rate swap agreement.
Odd Lot: a quantity of securities which is less than the typical cash market trading
unit, e.g., an odd lot for a Treasury security is a par amount of less than one million
dollars. The bid-ask spread on an Odd Lot is slightly wider than for a round lot.
Offer: the lowest declared price at which a seller is willing to sell a security at a
particular time. Opposite of bid.
Offset: the liquidation of a purchase of futures through sale of an equal number of

contracts of the same delivery month or the covering of a short sale of futures
through the purchase of an equal number of contracts of the same delivery month.
Either action cancels the obligation to make or take delivery of the commodity.
Open Interest: the total number of future contracts in a given commodity which
have not yet been liquidated by offset or fulfilled by delivery; the total number of
open contracts. Each open contract has a buyer and a seller; however, when
calculating the open interest of an exchange, only one side of the contract is counted.
Open Position: a forward or futures contract is open if it has not been fulfilled by
delivery or liquidated by offset. The open position includes open long and short
contracts, including option contracts that have not been exercised.
Option: a contract that grants the option buyer the right or privilege, but not the
obligation, to buy or sell a specified amount of a given financial instrument at a
fixed price (the exercise price) before or on a designated date (the expiration date). A
call option confers on the option buyer the right to buy the financial instrument. A
put option confers on the option buyer the right to sell the financial instrument. The
option writer has the obligation of performing if the option is exercised timely by the
option buyer. See also “Standby Commitment”, “Optional Commitment”,
“Exercise Price”, “Expiration Date”.
Option Adjusted Spread (OAS): represents an expected incremental return

(spread) over Treasury rates, given the observed market price for a security. The
OAS is normally positive and reflects the risks of the security, including option risk,
relative to a Treasury security. A Treasury security will have an OAS of zero. A
negative OAS means a security is expected to earn less than a Treasury security of
comparable maturity.
OAS is calculated using an iterative modeling process. First, a large sample of

potential Treasury interest-rate paths consistent with the current term structure and
current level of volatility are generated; second, the cash flows of the security for
each of those Treasury interest-rate paths are generated; third, the cash flows are
discounted using the projected Treasury rates to compute an estimated model price.
The estimated model price is then compared to the observed market price of the
security. If the model price is greater than the market price, an increasingly larger
spread is added to each of the Treasury rates and the process of discounting cash
flows is repeated until the model price equals the market price. OAS is the spread
that results in the estimated model price equaling the observed market price.
When OAS is calculated using Treasury rates as discount rates, the OAS includes
both option spread and credit spread. Thus, occasionally OAS may be calculated
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using a corporate interest-rate curve, such as LIBOR, to compute primarily the

spread arising from the embedded optionality.
Given a reasonable estimate for OAS, a fair (model) value can be calculated for a
security, using the current term structure of interest rates and the current level of
volatility.
Option Buyer: the purchaser of a call or put option who pays a premium to receive
the exercise right of the contract.
Option Writer: the seller of a call or put option who grants the exercise right to the
buyer in exchange for receiving the premium.
Optional Commitment: a term for an over-the-counter option; an option to receive

securities, exercisable at a future date. The buyer of the optional commitment has the
option to receive the securities. A long optional commitment is an option to purchase
securities. A short optional commitment is a commitment to sell. See also “Option
and Call”.
Optional Commitment Fee: amount paid for the purchase of an optional

commitment. Also called a “Premium”.
Original Margin: term applied to the initial deposit of performance bond or margin
money required of clearing member firms by clearing house rules.
Origination: the process whereby a bond, such as a GNMA certificate, backed by

approved mortgages in a pool, is issued. See “Issuer”.
Originator: one whose function is to originate or issue mortgage-backed securities.

Builders, brokers, and others are solicited to obtain applications for mortgage loans.
The individual mortgage company which performs this function is also designated as
the originator or issuer. See “Issuer”.
Out-of-the-Money: an option that has no value if exercised under current market

conditions (e.g., the option to purchase is at $100, while the market price is below
$100). Such an option has no intrinsic value, but may have time value. A call option
is out-of-the-money when the exercise price of the option is higher than the
underlying security’s price. A put option is out-of-the-money when the exercise
price is lower than the underlying security’s price.
Output: the volume of mortgage securities that a mortgage company can be

expected to issue in a month. Also called “Production” or “Origination”.
Overcollateralization: the value of the collateral for an asset-backed security

exceeds the par amount of the asset-backed security. From the perspective of the
issuing entity, the extent to which the value of the asset or the cash flow produced by
the asset (collateral) exceeds the liability or the cash flow required to meet the
liability obligations. It is usually expressed as a percentage of par amount of the
liability.
Over-The-Counter (OTC): 1 ) non-exchange traded instruments, including

Treasury securities, mortgage-backed securities, municipal securities, negotiable
CDs, swaps, forwards, and certain options. 2) a market that is not part of an
organized exchange.
Page 12A-28
Overtrading: see “Adjusted Trading” and “Fee Trading”.
P&I: abbreviation for “principal and interest.” This is customarily used to describe
the regular monthly checks paid to the registered owner of mortgage-backed
securities by the issuer. Payment of GNMA I P&I is scheduled to arrive by the
fifteenth of each month and contains the interest, regular principal payments, and
prepayments made on a pro rata basis by the entire pool for the previous calendar
month.
PAC (Planned Amortization Class): a CMO tranche which is protected, to some

degree, from both prepayment and extension risk. The CMO pays principal
according to a predetermined schedule that is expected to be met if the collateral
prepayment speed remains within the PAC band, that is, between the two specified
prepayment speeds.
Pair Off: the matching or netting of contra transactions between two parties when
delivery is due. Only the unmatched balance is delivered with a check for the
difference between the purchase and sale prices of all transactions being received or
delivered. This reduces the number of physical deliveries and redeliveries which
otherwise would be required. A pair-off transaction is a security purchase transaction
that is closed or sold at, or prior to the settlement or expiration date.
Papers: term sometimes given to put or call options.
Par Cap: a provision in the contract of sale for GNMA securities which restricts
delivery only to pools which bear an interest rate sufficiently high so that the
securities would trade at or below par when computed on the agreed-to yield.
Par Value: the face value of a security.
Participation Certificate: a type of mortgage-backed security which represents an

undivided interest in certain real estate loans.
Pass-Through: a mortgage-backed security on which payment of interest and

principal on the underlying mortgages are “passed through” to the security holder
by an agent shortly after interest and principal payments are received from the
mortgage borrowers.
Pay Down: when the dollar value of a new issue of Government securities is less
than the maturing issue which it replaces, the difference is called the pay down.
Paying Agent: an agent, usually a commercial bank, engaged by an issuer to effect

dividend or interest payments periodically.
Pay Up: when the dollar value of a new issue of Government securities is more than
the maturing issue which it replaces, the difference is called the pay up.
Permanent Investor: one who provides permanent mortgage financing.
PhysicaVDefinitive Security: a security for which there exists a physical paper

document as a certificate of ownership identifying terms and conditions.
Plus (+): describes an additional 1/64th (PIPquotations. For example, 98.4+ means 98
and 4/32nds, plus an additional 1/64th.
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Point: 1) an amount equal to one percent of the face value or principal amount of an
investment or note. 2) a mortgage loan discount point, which is a one-time charge
assessed at closing by the lender to increase the yield on the mortgage loan to a
market rate. 3) in the foreign-exchange market, the lowest digit at which the
currency is quoted, e.g., “one point” is the difference between sterling prices of
$1.8080 and $1.8081. Also calledpips.
Pool: a collection of mortgages which are packaged and sold as a security. Holders
of GNMA pass-through securities own a pro rata share of the outstanding balance of
all mortgages in the same pool. Pools must be mortgages of the same kind (single
family, mobile home, or projects), carrying the same or similar rate of interest, and
must all be of the same or similar maturity (e-g., 30 years). All mortgages within a
single pool are serviced by the same issuer and are usually from the same geographic
area.
Position: an interest in the market, either long or short. Securities purchased and
held are a long position. Securities sold short and not yet covered are a short
position. Forward or futures contracts purchased are called a long position. Forward
or futures contracts sold and not yet liquidated are called a short position. A call
option purchased and a put option sold economically are equivalent to a long
position. A put option purchased and a call option sold economically are equivalent
to a short position. See also “Open Position” and “Net Position”.
Position Limit: the maximum number of speculative futures contracts in one

commodity that a person or group of persons acting in concert can hold as
determined by the Commodity Futures Trading Commission or the exchange upon
which the contract is traded.
Positive Yield Curve: See “Normal Yield Curve”.
Premium: 1) the amount by which the current market price exceeds the security’s
face value, 2) the amount paid to purchase an option, 3) the amount by which the
redemption price exceeds a callable security’s face value, 4) loosely, refers to the
higher yield demanded by the market for CDs and securities issued by a particular
institution as a result of higher perceived credit risk of that institution relative to
other similarly rated institutions (also referred to as “paying up for funds”), 5 ) in the
case of federally insured zero-coupon CDs, the amount of the purchase price in
excess of the original (or accredited) issue price charged by Broker-Dealers to
secondary market investors, which is not FDIC-insured, 6) refers to a higher price
charged for a security that is in short supply relative to other similar securities, as in
the phrase, “the old 2- year is at a premium to the When Issued 2- year.”
Prepayment: payment made ahead of the scheduled payment date.
Prepayment Model: an empirical method which produces a reasonable and

supportable forecast of mortgage prepayments in particular interest rate scenarios.
The estimated prepayment speeds from such models typically are available from
securities broker-dealers and industry-recognized information providers. These
estimated prepayment speeds are used in tests to forecast the weighted average life,
change in weighted average life, and price sensitivity of CMOS and mortgage-
backed securities. The estimated prepayment speeds usually are expressed in terms
of a prepayment benchmark, either “Constant Prepayment Rate (CPR)” or “PSA”.
Page 12A-30
Prepayment Risk the potential that all or part of the principal of a security, such as
a mortgage-backed security, will be paid earlier than expected, typically in response
to falling interest rates.
Price Limits: the maximum price advance or decline from the previous day’s
settlement price permitted for a contract in one trading session by the regulations of
a futures exchange.
Prime Rate: the interest rate at which preferred customers can borrow from
commercial banks.
Primary Dealer: dealer in Treasury securities which reports its activities and
resource commitments to the Federal Reserve Bank of New York and with whom
the Federal Reserve conducts open market operations to expand or contract the
money supply. To maintain their status with the Federal Reserve, primary dealers
must maintain an active market-making role in Treasury securities.
Primary Market: offerings in a security at its issuance. See also “Secondary

Market”.
Principal: (as contrasted with Agent) a party who buys and sells for his or her own
account in an arms-length transaction with another, and who is not required to
disclose the price basis of a transaction.
Principal Balance: the actual balance of an obligation exclusive of accrued or

unpaid interest.
Principal Transaction: a securities transfer wherein one or both of the parties acts
as principal dealing for hisher own account.
Private Placement: a security issue offered only to a limited number of

sophisticated investors, as opposed to being publicly offered. Subject to certain
securities laws, a Prospectus for a Private Placement does not have to be registered
with the SEC.
Production: the aggregate of mortgages assembled by a mortgage company, e.g., if

a mortgage company generates $1 million per day of new mortgages, it is said to be
a $5 million a week producer.
Prospectus: a detailed statement prepared by an issuer and filed with the SEC prior
to the sale of a new issue. The prospectus gives detailed information on the issue and
on the issuer’s condition and prospects.
Proxy: when one person acts on behalf of another, the first person is acting as proxy
for the second. Similarly, one instrument can be viewed as a proxy for another when
the primary instrument is unavailable or too costly. Warehouse receipts or depository
receipts may be used as proxies for commodities or securities.
PSA: a prepayment speed benchmark used for expressing estimated prepayment

rates for CMOS. The PSA benchmark assumes slow, but rising, prepayments during
the first thirty months, then level prepayments in subsequent months. Thirty months
after issuance, a speed of 100% PSA is equal to a 6% CPR. The name derives from
the Public Securities Association (now The Bond Market Association), which was an
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EXAMINER’S GUIDE
association of dealers in government securities that served as the trade association

for brokers and dealers in exempt securities.
Purchased Interest Receivable: interest due to the previous owner of an investment

that is paid to the new owner. This accrued interest is part of the transaction’s cost,
but is not reflected in the investment’s quoted price. The receivable is eliminated
when the first coupon payment is received.
Put: 1) an option contract granting the buyer the right, but not the obligation, to sell
(put) a specified quantity of a security at a specified price (the exercise or strike
price) and time (the exercise style). Such an option is bought with the expectation of
a price decline below the contract price. If the price decline occurs, the purchaser
will exercise the option. If the decline does not occur, the purchaser will let the
option expire and will lose the purchase price of the option, that is, option premium.
2 ) an embedded put in a security grants the holder the right to retire or “put back to
the issuer” all or part of the security at a specific price (the put price) and at a
specific time prior to its contractual maturity date. The ability to put the security is
an “option” that belongs to the holder of the bond. See “Option”; compare with
“Call”.
Pyramiding: successive borrowing on securities to finance the purchase of

additional securities.
Quality: a reference to the credit quality of a security. A security is said to be of

high quality if the return on principal and the payment of interest are well secured or
guaranteed.
Quotation: the bid to buy and the offer to sell a security in a given market at a given
time. Often shortened to “quote.” See also “Bid” and “Asked”.
RangeIAccrual Note: a note with a coupon determined by whether the underlying

price or rate falls within a specified range, e.g., for a typical LIBOR-based range
note, no interest is paid if the LIBOR rate is outside of the specified range.
Rate of Interest: the coupon rate of a security; the annual interest rate of a pool.
Usually not equal to the yield. See “Bond Equivalent Yield”.
Real Estate Syndicate: a group of investors who pool funds for investment in real
property.
Refunding: the process of issuance of a new security to replace a security that was
redeemed before maturity. Usually used in reference to a municipal security that was
called.
Registered: 1) a security that is issued in the name of the owner or the owner’s
nominee. 2 ) opposite of exempt. A registered security may not be issued without the
filing of a registration statement with the SEC.
Regular-way Settlement: 1 ) delivery of a security by a seller to a buyer within the

number of days (between the trade date and the delivery date) that the securities
industry has established for a particular type of security for normal settlement, e.g.,
regular-way settlement is three business days after the trade date for agency
securities and once a month on the earliest scheduled date for mortgage-backed
securities 2) delivery of a security for spot delivery, as opposed to forward delivery,
Page 12A-32
e.g., a US government security may settle for spot delivery on the same (cash), the
next (regular), or the second (skip) day after the trade date.
Regulation T: the name for the Federal Reserve Board‘s regulation governing the
amount of credit that brokers and dealers may extend to customers who buy
securities.
Regulation U: the name for the Federal Reserve Board’s regulation governing the
amount of credit that banks may extend to customers who borrow money to buy
securities on margin.
REMIC (Real Estate Mortgage Investment Conduit): a CMO issued after

January 1, 1987, through a financing vehicle created by the Tax Reform Act of
1986. A pass-through entity that can hold mortgages secured by any type of real
property and issue multiple classes of ownership interests to investors in the form of
pass-through certificates, bonds or other legal forms. See “ CMO’ .
Remote: 1) isolated, as in bankruptcy remote. 2) non-recurring. Per FASB,

“isolated, nonrecurring, and unusual” encompasses the “extremely remote ‘disaster
scenarios’ (such as a run on the credit union).” This type of event would not be
anticipated by a credit union in deciding whether it has the positive intent and ability
to hold a debt security to maturity. Other events, no matter how infrequent or
remote, that are related to on-going business activities, such as the construction of a
building or the payment of claims by an insurance company, are not considered
“isolated, nonrecurring, and unusual” under SFAS 1 15.
Repurchase Agreement (Repo): a security sold subject to an agreement to

repurchase at a specified price on an agreed forward date. From the broker’s
standpoint, this transaction occurs when a security is sold to a counterparty (e.g.,
credit union) with the obligation that the broker will repurchase the security at a later
date. (Industry terminology uses the broker’s standpoint.)
Residual: the difference between the cash flows originating from the collateral of a
mortgage pool and the funds needed to h n d the securities supported by the
collateral. Among the CMOS issued by a REMIC, the residual has special tax
consequences.
Revenue Bond: See “Municipal Security”.
Reverse Repurchase Agreement (Reverse Repo): a security purchased subject to

an agreement to resale at a specified price on an agreed forward date. From the
broker’s standpoint, this transaction occurs when a security is purchased from a
counterparty (e.g., credit union) with the obligation that the counterparty will
repurchase the security at a later date. (Industry terminology uses the broker’s
standpoint.)
Rich: Wall Street vernacular for a high value ofone security relative to another in
terms of its historical price relationship. If a security is said to be rich, it is believed
to be overpriced relative to another security. See also “Cheap”.
Roll Over: using funds received from a maturing security to reinvest in a similar
new security.
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Round-Lot: the usual minimum unit of trading (normally $1,000,000 or more in

Governments.)
Safekeeping: a term that refers to the storage and protection of securities provided
as a service by a bank or institution acting as agent for the customer. Since
ownership interests in most securities now are held as securities entitlements in
book-entry form, the broader term is custodian.
Safety: an attribute of an investment. Safety is often associated with securities that

have a short maturity and a low credit risk arising from insurance or government
guarantee.
Seasoning: the aging of a mortgage. The amount of time that has elapsed since
origination.
Secondary Market: the resale market for securities. See also “Primary Market”
Section 107(8) Institution: an institution in which a credit union may make a

deposit as authorized under Section 107(8) of the Federal Credit Union Act (12 U S
C 1757(8)), e.g., an institution that is insured by the FDIC or a state bank, trust
company, or mutual savings bank operating in accordance with the laws of a state in
which the credit union maintains a facility.
Securities and Exchange Commission (SEC): an agency established by Congress

to regulate the corporate securities market. Brokers and dealers in securities are
required to register with the SEC.
Securities Industry Association (SIA): a trade association of securities dealers.
Securities Investor Protection Corporation (SIPC): a federally chartered

corporation that provides insurance for customer accounts carried by US broker-
dealers. The insurance protects against safekeeping losses from failure of the broker-
dealer up to $500,000.
Securities Lending: lending a security to a counterparty, directly or through an

agent, and receiving as collateral an amount of money or securities in return. The
value of the collateral usually is greater than the value of the loaned security. A fee
is earned by the lender. Similar to “Reverse Repurchase Agreement”.
Security: a common or preferred stock, a bond, a US Government or agency issue,

or a state or municipal obligation. See also “Negotiable Security”.
Self-Regulatory Organization (SRO): any organization which develops regulations

for its members and enforces the regulations. Typically, enforcement is obtained by
expulsion of members who do not follow the regulations.
Seller-Servicer: an approved corporation that sells mortgages to, and services

mortgages for, FNMA, GNMA, and/or FHLMC.
Seller’s Option: the right of a seller to select, within the limits prescribed by a
contract, the quality of the commodity delivered and the time and the place of
delivery.
Page 12A-34
Selling Hedge: selling futures contracts to protect against possible decreased prices
of commodities. Usually called short hedge. See “Hedge”.
Sell Out: action taken by a broker or a dealer to liquidate an account or a transaction

for failure to maintain proper margin or to make timely payment.
Serial Bonds: a multiple bond issue in which the maturities are staggered over a
number of years.
Servicing: the duties of the mortgage banker as a loan correspondent, per

specifications in the servicing agreement for which a fee is received. The collection
for an investor of payments, interest, principal, and trust items (e.g., hazard
insurance and taxes), on a note by the borrower in accordance with the terms of the
note. Servicing also consists of operational procedures covering accounting,
bookkeeping, insurance, tax records, loan payment follow-up, delinquent loan
follow-up, and loan analysis.
Servicing Agreement: a written agreement between an investor and a mortgage loan

correspondent stipulating the rights and obligations of each party.
Settlement: an act that discharges obligations in respect of funds or securities

transfers between two or more parties, e.g., settlement of a security transaction
typically is by delivery of securities in proper form to the buyer and delivery of
funds in proper form to the seller on the settlement date.
Settlement Date: the date agreed upon by parties to a security transaction for the
payment of hnds and the transfer of the security. Trades that are not settled on the
settlement date are said to fail.
Settlement Price: the price at which a security or a commodity is to be settled. Used

primarily in connection with clearing house operations. In commodity trading, the
settlement price is based on the closing price or the range of closing prices.
Short Covering: the purchase of securities so that securities previously sold to make
delivery on a short sale may be returned. To close a short position.
Short Hedge: see “Selling Hedge”.
Short Option: an option that has been sold.
Short Sale: the sale of a security not owned by the seller. The seller anticipates
being able to purchase the security at a later time at a lower price. To make delivery
on the short sale, the seller will obtain the security through borrowing (securities
lending) or a reverse repurchase agreement.
Short the Basis: the purchase of futures as a hedge against a commitment to sell in
the cash market.
Short (vs. Long) Bond: Wall Street refers to the short bond as a US Treasury
security with a maturity of two years. See “Long Bond”.
Short-Term Investment Fund (STIF): a collective investment fund maintained by

a national bank under 12 CFR Part 9, that is restricted to a dollar-weighted average
portfolio maturity of 90 days or less similar to a Money Market Mutual Fund.
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Small Business Administration Secondary Participation: a security that

represents the guaranteed portion of a SBA loan that is sold by a lending institution
to a secondary participant. Also called a “Guaranteed Loan Participation Certificate
(GLPC)”.
Small Business Related Security: a security as defined in $3(a)(53) of the

Securities and Exchange Act of 1934, i.e., a security, rated in one of the four highest
rating categories by a nationally recognized statistical rating organization, that
represents ownership of one or more promissory notes or leases of personal property
which evidence the obligation of a small business concern. It does not mean a
security issued or guaranteed by the Small Business Administration.
Slow-Pay Bonds: bonds in a low priority class compared with bonds in other classes
with respect to the order of redemption, which may result in slow redemption when
compared to other classes.
Speculate: to buy or sell securities, commodities, futures, or forward contracts

without a natural hedge or a bona fide hedge, e.g., a natural hedge would be to buy a
security funded by a deposit liability of similar duration. To trade (e.g., GNMAs)
with the hope of quick profit by market movement as opposed to investment income.
See “Speculator”.
Speculator: one who trades with the objective of achieving profit through the
successful anticipation of price movements. In commodity futures, a speculator is
any person with a position that is not a bona fide hedge as defined by the
Commodity Futures Trading Commission.
Spot: refers to the characteristic of being available for immediate or nearly

immediate delivery. Cash market transactions usually are grouped into two kinds -
spot and forward contracts. An outgrowth of the phrase “on the spot.“
Spot Commodity: see “Actuals”
Spot Month: in futures trading, the nearby contract month, in which case delivery
usually is possible at any time. However, such trading is in a futures contract.
Spot Price: the price at which a financial instrument or physical commodity is

selling at a given time and place. Same as cash price.
Spread: the difference between yields on securities of different quality or different

maturity. The difference between bid and ask price is also called the spread.
Spreading: the purchase of one futures contract and the sale of another, in the
expectation that the price relationships between the two will change so that a
subsequent offsetting sale and purchase will yield a net profit. Examples include: (a)
the purchase of one delivery month and the sale of another in the same commodity
on the same exchange, (b) the purchase and the sale of the same delivery month in
the same commodity on different exchanges, (c) the purchase of one commodity and
the sale of another (wheat vs. corn or GNMAs vs. long-term US Treasury Bonds),
and (d) the purchase of one commodity and the sale of the products of that
commodity (soybean vs. soybean oil and soybean meal). When the terms of the
contract and all other relevant factors indicate that the price relationships between
the contracts should be constant, but price discrepancies develop due to temporary
supply-demand imbalances, spreading operations to take advantage of such
Page 12A-36
discrepancies are sometimes erroneously called arbitrage. Spreading generally

involves the making of judgments about price relationships which are subject to
gradual change due to economic factors which vary over a period of time and is,
therefore, a form of speculation.
Standby Commitment: a commitment to either buy or sell a security, on or before a

future date, at a predetermined price. The seller of the commitment is required to
either accept delivery of a security (in the case of a commitment to buy) or make
delivery of a security (in the case of a commitment to sell), in either case, at the
option of the buyer of the commitment. See “Option”.
Standby Fee: the fee charged by an investor for a standby commitment. The fee is
earned upon issuance and acceptance of the commitment.
Stop-Loss: a method of limiting the amount of loss caused by a decline in the

market value of an investment by establishing a “low”point at which an investment
will be sold.
Street Name: a registered security which has been endorsed in blank or endorsed in
favor of a recognized dealer is said to be in street name. A security may remain in
the broker’s name as long as the credit union is the beneficial owner of the security.
Strike Price: the price at which a security underlying a call (or put) option can be
purchased (or sold) upon exercise during the period specified in the contract. Also
called “Exercise Price”.
Strips or Stripped Treasuries or STRIPS: see “Zero Coupon Treasury Bonds”.
Stripped Mortgage-Backed Security: a mortgage-backed security that has been

separated into principal and interest components. Stripped mortgage-backed
securities are not permissible investments for natural person federal credit unions.
Structured Note: a security with a coupon, average life, or redemption value that is
linked to a) changes in an underlying index; b)changes in the prepayment speed of a
mortgage-backed security used as a reference for the structured note; or 3) other
factors. A government sponsored enterprise may issue structured notes to reduce the
agency’s cost of funds. The risk of embedded options make some structured notes
unsuitable investments for federal credit unions.
Stuffed Pig: a transaction initiated by a dealer for a client without authorization

from the client. See also “Wooden Ticket”.
Subordinated Debenture: an unsecured debt obligation that is junior in payment

priority to other senior bonds. In the event of bankruptcy, the claims of the
unsecured debt holders are paid after those of senior unsecured debt holders.
Swap: 1) a contract between two parties to exchange cash flows in the future based
on an agreed formula. A swap is a bundle of forward contracts. Swaps are available
in and between all active financial instruments. a) The “ plain vanilla” interest rate
swap agreement is an agreement to exchange fixed interest payments for floating-
rate payments based on a notional principal amount. The notional principal amount
is not exchanged in an interest rate swap. b) A generic currency swap is an
agreement to exchange one currency for another, at the beginning and at the end of
the swap, and to make fixed interest rate payments based on the currency obtained
Page 12A-37
Tick: the typical minimum price increment in cash market quotations, e.g., one
thirty-second of one percent, .03 125% or .0003 125, in US Treasury securities.
Time Value: the part of the option premium that reflects the remaining life of the
option. The total option value is the sum of its intrinsic value and its time value. The
more time that remains before the expiration date, generally the higher the premium,
because more time is available for the value of the underlying security to move up or
down.
To Be Announced (TBA): a delayed-delivery contract. A contract for the purchase

or sale of a mortgage-backed security to be delivered at an agreed upon future date,
but that does not specify an identified pool number and number of pools. Trading in
these securities is often done on a yield basis.
Total Return: the sum of interest and principal payments, the income earned on the
reinvestment of these cash flows, and the change in fair value over a specific holding
period (horizon) for a specific security.
Trade: either a purchase or a sale of a security.
Trade Date: the date on which parties enter into an agreement, orally or in writing,
for the purchase or sale of a security.
Trading: the act of entering into purchases or sales of a security.
Trading Income: income derived from the trading of a portfolio of securities.
Trading Profits o r Losses: profits or losses resulting from the trading of a portfolio
of securities.
Transfer: when a registered instrument is acquired, it is sent to the transfer agent for
transfer. The transfer agent records that this certificate is no longer owned by the
previous holder but is now owned in the name of the individual who has acquired it.
Transfer Agent: an entity appointed to maintain records of securities owners, to

cancel and issue certificates and to address issues arising from lost, destroyed or
stolen certificates.
Treasury/U.S. Government Obligations: negotiable debt obligations of the US

Government secured by its full faith and credit.
Treasury Bill (T-Bill): a direct obligation of the US Government issued at regular

auctions on a discount basis from face value for original maturity periods of 13
weeks to 52 weeks.
Treasury Bonds: a direct obligation of the US Government issued at regular

auctions. Currently issued in original maturity of 30 years. Treasury bonds are
coupon instruments with serni-annual interest payments.
Treasury Notes: Treasury notes have the same characteristics as Treasury bonds
except that the original maturities range from one to ten years.
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EXAMINER’S GUIDE
Twelve-Year Life: historically, an assumption that the cash flow associated with a
mortgage will consist of level payments until the twelfth year, when the remaining
principal balance is paid in full.
Uncovered Call Writer: a call writer who does not own the underlying financial
instrument on which the option is written. Also called a naked call writer.
Underlying: the security, cash commodity, forward, futures, swap, or other contract
or instrument that is the subject of a derivatives contract or instrument.
Underwriting: 1) any person who has purchased from an issuer with a view to
distribute any security. Securities dealers use this term to designate the issue of
origination of new securities. 2) the process used by a Mortgage Banker to analyze
risk and the matching of risk to an appropriate rate and term.
Uniform Commercial Code (UCC): a comprehensive model statute to simplify and

clarify the law governing c,ommercial transactions, designed to make uniform the
laws of the states. It has been adopted, with modification, by most states.
Unit Investment Trust: an investment company similar to a mutual fund, but which
issues only redeemable securities (units), each of which represents an undivided
interest in a portfolio of securities.
Up-Front Fee: see “Fee”
Variation Margin: in futures trading, a payment made on a daily or intraday basis

by a clearing member to the clearing organization based on adverse price movement
in positions carried by the clearing member. Variation margin is a cash payment, as
opposed to maintenance margin, which is a value (in cash or eligible securities)
which must be maintained on deposit as a performance bond. Individuals may be
subject to a margin call to replenish the performance bond to the initial margin level
in the event the value drops below the maintenance margin level.
Vega: a measure of the change in an option’s price for a given change in the
volatility of the underlying security.
Volatility: a measure of a security’s actual or expected price movement over a

specific time period. Usually this is the standard deviation of proportional changes in
the asset’s price.
Warehousing: the borrowing of funds by a mortgage banker on a short-term basis at

a commercial bank, using permanent mortgage loans as collateral. This form of
interim financing is used until the mortgages are sold to a permanent investor. It is a
form of “line of credit“ financing.
Weighted-Average Coupon (WAC): the arithmetic mean (dollar-weighted) of the

coupon rate of the underlying mortgages that collateralize a security as of its issue
date. This is the same calculation used for WAM except using the mortgage coupon.
Weighted Average Life: the arithmetic mean (doh--weighted) of the time to

principal repayment of a security. WALs for CMOS and mortgage pass-through
securities are calculated under a prepayment assumption. The WAL is a commonly
used maturity measure in the mortgage market. Since the weighted-average lives of
Treasuries are equal to their maturities, the par yield curve for Treasuries provides a
Page 12A-40
natural benchmark for pricing mortgage-backed securities of various projected

average lives.
Weighted-Average Maturity (WAM): the arithmetic mean (dollar-weighted) of the

remaining term of the underlying mortgages that collateralize a security as of its
issue date. This is the sum of the principal balance of each mortgage in the pool
times its months to maturity divided by the total principal balance of the mortgages
in the pool. Subsequent to issuance, estimates are made of the expected average
remaining term assuming no prepayments.
When Issued (WI): short for when, as, and if issued. Transactions prior to issuance
of a security are on a WI basis, because the transaction is conditional on issuance,
although the security has been authorized. The when issued trading period in US
Treasury securities is normally three to ten days. However, interest does not accrue
during the when issued period, and payment is not required until the settlement date.
When issued trading in Treasury securities occurs on a yield basis prior to the
auction (sometimes denoted w.w.i.) and on a price basis following the auction
(denoted w.i.).
Wooden Tickets: a transaction initiated by a dealer for a client without

authorization. See ‘Stuffed Pig’.
Writer: the grantor of an option contract. Also called the “Maker”.
Yield: the yield on a bond is the annual percentage of return that it pays, typically
based on a semi-annual coupon convention. By way of comparison, the annual
percentage yield (APY) is based on an annual compounding convention. In real
estate, the term refers to the current yield, that is, the effective annual amount of
income which is being accrued on an investment, expressed as a percentage of the
price originally paid. See also “Net Yield”.
Yield Curve: a graph illustrating the level of interest rates as a function of time to
maturity. The most common yield curve plots Treasury securities from the 3-month
Treasury bill to the 30-year Treasury bond. Yield Curves may be described as a) a
normal yield curve (short-term rates are lower than long-term rates); b) an inverted
yield curve (short-term rates are higher than long-term rates); and 3) a flat yield
curve (little difference between short-term and long-term rates).
Yield on Average Life: historically, GNMA yields were quoted from tables which
calculated the yield on a single loan prepaid at the end of 12 years. It was assumed
that such a yield calculation was fairly representative of a pool of loans wherein the
average loan life was thought to be 12 years. No longer a basis of trading.
Yield Maintenance Contract: concurrent commitment to purchase a security via a

cash forward agreement and to sell the same security on the same settlement date via
a standby commitment. Also refers to a forward contract written with terms which
maintain the yield at a fixed rate until the delivery date.
Yield to Call: the bond-equivalent yield that an investor would receive on his
investment if he were to buy a particular security at the quoted asked price and the
bond was called on the call date.
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EXAMINER'S GUIDE
Yield to Maturity: the bond-equivalent yield that an investor would receive on his
investment if he were to buy a particular security at the quoted asked price and hold
to maturity.
Zero Coupon Bond: a security that makes no periodic interest payments and is sold
at a discount from face value. Zero coupon bonds that mature more than ten years
from settlement date are not permissible under Part 703.
Zero Coupon CMOS: CMO bonds that are either true zero coupon instruments or
accrual bonds. An accrual bond (or compound interest bond) is a coupon bond that,
during some part of its life, accumulates accrued interest as increased principal rather
than as cash paid. This accumulation is called accretion.
Zero Coupon Treasury Bonds (STRIPS, Stripped Treasuries): a Treasury

security with a single cash flow at maturity. These securities result from the
separation of the principal (corpus) and interest (coupon) portions of US
Government obligations. Most zero coupon Treasury securities are in the Federal
Reserve book-entry system under the STRIPS program, Separate Trading of
Registered Interest and Principal of Securities. The holder of a corpus strip has the
right to receive the principal balance on the maturity date. The holder of a coupon
strip has the right to receive the periodic interest payment on the coupon payment
date. These instruments are sold at a discount from the value to be received on the
due date. Prior to the STRIPS program, Wall Street firms issued ownership interests
in trusts that stripped Treasury securities. As a transitional measure, the Federal
Reserve registered stripped physical coupons as CUBES, Coupons Under Book-
Entry System.
Page 12A-42
Chapter 13
ASSET LIABILITY MANAGEMENT (ALM)
TABLE OF CONTENTS
PART 1 ASSET LIABILITY MANAGEMENT (ALM) .............................................. 13/1-1

Associated Risks .................................................................................................. 13/1-1
Overview.............................................................................................................. 13/1-1
Reference ............................................................................................................ .13/ 1-3
PART 2 ALM - INTEREST RATE RISK ...................................................................... 13/2-1
Overview............................................................................................................. .13/2- 1
IRR Examination Procedures............................................................................... 1312-3
Complex Investments............................................................................... 13/2-3
Policies and Procedures ....................................................................................... 13/2-4
Planning and IRR Management ........................................................................... 13/2-9
Oversight, Monitoring, and ALCO ...................................................................... 13/2-11
IRR Measurement ................................................................................................ 13/2-15
IRR Measurement Staff Review .............................................................. 13/2-15
Review of IRR Measurement System ...................................................... 13/2- 17
IRR Measurement Techniques and Level of Risk ................................... 13/2-20
IRR.Measures........................................................................................... 13/2-22
Gap Analysis ............................................................................................ 13/2-23
Income Simulation ................................................................................... 13/2-23
Asset Valuation and NEV ........................................................................ 13/2-24
Red Flags ............................................................................................................. 13/2-24
Interest Rate Risk and CAMEL ........................................................................... 13/2-26
Workpapers and References............................................................................................. 13/2-27
PART 3 ALM .LIQUIDITY RISK ................................................................................ 13/34
Overview.............................................................................................................. 13/3-1
Managing Liquidity Risk ..................................................................................... 13/3-1
Examination Guidance ......................................................................................... 13/3-2
Liquidity Policies ................................................................................................. 13/3-3
Ratios ....................................................................................................... 13/3-5
Setting Limits........................................................................................... 1313-6
Other Measures ........................................................................................ 13/3-7
Monitoring and Oversight ........................................................................ 1313-7
Reporting................................................................................................. .13/3.9
Sources of Liquidity ............................................................................................. 13/3-9
. . . .................................................................... 13/3-13
Backup Sources of Liquidity
Activities Affecting Liquidity .............................................................................. 13/3-14
Borrowed Funds ....................................................................................... 13/3.14
Repurchase Agreements........................................................................... 13/3-15
Non-member Deposits ............................................................................. 13/3-16
Real Estate and Other Loan Sales ............................................................ 13/3-16
Loan Participations .................................................................................. 13/3- 17
Workpapers and References................................................................................ .13/3.18
APPENDIX 13A .INTEREST RATE RISK MEASUREMENT TOOLS .................... . 1 A. 31
APPENDIX 13B .DISCOUNTING CASH FLOWS...................................................... 13B-1
APPENDIX 13C .GLOSSARY OF TERMS ................................................................. 13C-1
Chapter 13 - Part 1

Examination Determine safety and soundness of the credit union’s Asset
Objectives Liability Management (ALM) process
Determine whether the credit union effectively manages its
balance sheet
Alert the officials to existing or potential weaknesses resulting
from the ALM process
Associated Interest rate risk (IRR) - the risk that changes in market rates
Risks will adversely affect a credit union’s capital and earnings;
Liquidity risk - the current and prospective risk to earnings or
capital arising from a credit union’s inability to meet its
obligations when they come due;
a Strategic risk - the current and prospective risk to earnings or
capital arising from adverse business decisions, improper
implementation of decisions, or lack of responsiveness to
industry changes; and
Reputation risk - the risk that the credit union cannot meet
member loan and share funding requests, causing concerns about
the credit union’s solvency.
Overview ALM is the process of evaluating balance sheet risk (interest rate and
liquidity risk) and making prudent decisions, which enables a credit
union to remain financially viable as economic conditions change. A
sound ALM process integrates strategic, profitability, and net worth
planning with risk management. This process often includes an Asset
Liability Committee (ALCO), which has the central purpose of
attaining goals established by the short- and long-term strategic plans
without taking on undue risk. While smaller credit unions with
simple balance sheets may not have or need an ALCO, an ALCO
represents a sound business practice for larger institutions with more
product offerings (e.g., real estate loans.)
Page 13/1-1
EXAMINER’S GUIDE
Credit unions with effective ALM programs can better balance the
demands of meeting their members’ needs with the objectives of
maintaining financial strength and flexibility. Credit unions with
sound ALM processes recognize that ALM involves more than just
an IRR measurement program; they retain a global view of the
purpose of ALM. For example, ALM management includes activities
such as marketing, product pricing, investment analysis, cash
management, internal controls, and data processing, all while
understanding how external factors (e.g., laws, economic conditions,
sponsor support) affect the credit union.
Overall, successful ALM programs encompass the following

practices:
Identifying goals and objectives;

Developing strategies;
Creating polices and procedures;
Managing product offerings and pricing;
Identifying, measuring, monitoring, and controlling exposures to
risk;
Generating adequate income and net worth over varying
economic conditions; and
Maintaining financial flexibility.
Credit union boards have responsibility for overseeing the ALM

process, and usually delegate the day-to-day implementation to
management. Since ALM affects the entire scope of a credit union’s
operation (e.g., types of loans, loan rate structure, investments,
sources of funding, share rate structure, profit expectations, level of
risk, etc.), an effective ALM program requires an integrated process
of coordinating, analyzing, and communicating that includes all
operational units.
In larger credit unions, key players or operating units involved in the

ALM process generally include the chief executive officer (CEO)
and the chief financial officer (CFO), as well as management in the
areas of finance (investments), lending (credit) shares, and
marketing. Smaller credit unions may integrate the ALM process
within one or two key persons (e.g., CEO or CFO.)
~~
Page 1311-2
The primary objective of examiners’ ALM review involves analyzing

the credit union’s approach to ALM and assessing the level of
balance sheet risk exposure. Therefore, the examiner should ensure
management performs its due diligence by regularly analyzing the
structure of its assets (loan and investment products, rates, terms,
etc.) and liabilities (share products, rates, terms, etc.) to determine
the credit union’s potential risk exposure.
To ensure they maintain adequate net worth over a broad range of

possible economic conditions, credit unions should have in place a
process for (1) identifying, measuring, monitoring, and controlling
balance sheet risk; ( 2 ) monitoring financial performance; and (3)
actively managing (limiting) short- and long-term earnings
fluctuations. The officials should understand the reasons for any
balance sheet risk exposure. They should adjust the plan when
necessary to maintain positive earnings and sufficient net worth. In
this regard, ALM represents a decision-making tool for helping
credit unions realize stable earnings and appropriate net worth levels
over time as economic conditions change.
Sound, flexible ALM processes, which can respond to changing

market conditions, enable credit unions to make more prudent
decisions about their balance sheet growth and product mix. This
also enables the credit union to better serve their members’ needs
without incurring excessive or unreasonable levels of risk.
While the term ALM can encompass the broad area of balance sheet
risk, this chapter will focus on interest rate and liquidity risks
because they represent the most prominent risks affecting credit
unions. Part 2 of this chapter addresses Interest Rate Risk and Part 3,
Liquidity Risk. Although this chapter separately addresses each of
these risks, in reality, they interrelate with each other. That is,
actions that will affect a credit union’s IRR exposure will also likely
influence the liquidity risk exposure to some degree, and vice versa.
Refe renee IRPS 98-02, dated 1998, Supervisory Policy Statement on

Securities Activities and End- User Derivative Activities
Page 1311-3
131 /-L/ L3AJ

Chapter 13 - Part 2
ALM - INTEREST RATE RISK

Examination Determine the credit union’s exposure to interest rate risk (IRR)
Objectives 0 Evaluate how effectively management manages IRR exposure
a Communicate necessary concerns with management
0 Develop agreements for corrective action, as necessary
Associated 0 Interest rate risk (IRR) - the risk that changes in market rates
Risks will adversely affect a credit union’s capital and earnings;
0 Strategic risk - the current and prospective risk to earnings or
implementation of decisions, or lack of responsiveness to
industry changes; and
Reputation risk - the risks that the credit union cannot meet
Overview IRR is the potential decline in earnings and net worth arising from
changes in interest rates. This risk generally occurs because a credit
union may have a disproportionate amount of fixed and variable rate
instruments on either side of the balance sheet. Thus, as interest rates
change, the earnings stream or dividend expense on variable rate
balances will change while fixed rate balances will remain the same.
Accordingly, net income may rise or fall depending on the direction
of rate changes and whether the credit union is asset or liability
sensitive.’
Credit unions with sound interest rate risk management processes can
often avoid wide swings in net earnings (see Illustration 13-A.)
Asset sensitive means that the credit union has more assets that will reprice than
shares. Liability sensitive means that a credit union has more liabilities that will
reprice than assets. Repricing can occur due to maturities or resetting variable
instruments interest rates.
Page 1312-1
EXAMINER'S GUIDE
Illustration 13-A shows how the asset yield (interest income) of a

credit union can decline over time in response to falling market
interest rates. The graph depicts how this credit union adjusted its
cost of shares (interest expense) and thereby maintained a relatively
constant net interest income (NII) over time. Finally, the graph
shows net operating expenses as relatively constant and net income
positive over the period, with only a slight variance despite the
falling market interest rates.
Margin Analysis
Jun-99 Dec-99 Jun-00 Dec-00 Jun-01 Dec-01
Illustration 13-A
Small and basic service credit unions may have fairly simple IRR
processes. These may incorporate awareness of the members' share
and loan needs, relatively simple short-term loans and investments,
and flexible pricing policies that permit adjusting dividends and loan
rates to changes in market interest rates, thus maintaining adequate
earnings and net worth. In larger credit unions with more
complicated balance sheets, particularly those with higher
concentrations of long-term assets or more rate-sensitive deposits,
the credit union needs a more sophisticated and comprehensive
approach to IRR management. It also requires a more extensive
review by the examiner.
Page 1312-2
IRR The depth of analysis and time needed to review a credit union’s IRR
Examination management process varies from examination to examination. The
Procedures types of tests and level of examiner scrutiny will depend on the
complexity and size of a credit union’s balance sheet, from “simple”
to “complex.”
Credit unions having a conservative, short-term structure of shares,

loans, and investments may only need to demonstrate a basic
understanding of IRR. Aside from repricing their share and loan
products, simple credit unions generally pose lower IRR.
For larger credit unions or those with more complicated balance

sheets, the examiner should expect a more comprehensive IRR
management process. This should include a more sophisticated
analysis prepared and provided to the board on a regular basis with
measures of exposure to IRR.
The Interest Rate Risk Questionnaire (IRRQ) in AIRES is a flexible,

yet comprehensive tool to help the examiner determine the scope of
an IRR review. When examiners find little evidence of IRR, they can
narrow and focus the scope on a general review of the risk
management process. When a greater likelihood of IRR exists,
examiners should expand the scope to review and analyze the risk
management program in depth. Regardless of the credit union’s
approach to risk management, the examiner may use, as necessary,
Parts A through D of the IRRQ to document the review of certain
basic elements.
Complex As a first step, the examiner should determine whether the credit
Investments union has any loans secured by real estate or any complex
investments. According to Part 703 of NCUA Rules and Regulations,
complex investments have the following characteristics:
0 Embedded options (e.g., calls, interest rate caps or floors,

prepayments);
0 Remaining maturities greater than 3 years; or
0 Coupon formulas related to more than one index, or are inversely
related to, or multiples of, an index.
Page 13/24
EXAMINER’S GUIDE
In addition to these investments defined as complex by regulation,

other investments may exhibit sufficient risk to require treatment as
complex. Credit unions may have other investments carrying
significant risk that do not fall within the definition of complex;
however, these credit unions may require further examiner scrutiny
of their IRR management process. For credit unions with complex
investments, examiners should review the credit union’s procedures
for following the regulatory reporting requirements of $703.70 and
$703.90.‘ If examiners determine a credit union has a simple
structure, they can limit the scope of the examination.
Policies and The IRR examination review is mostly qualitative in nature with the
Procedures examiner looking at the various areas of a credit union’s IRR
management process. The examiner should review the credit union’s
IRR policies and procedures and determine if they adequately
correspond to the size and complexity of the balance sheet. The
credit union’s practices should effectively implement the policies and
procedures. Although the regulations do not require an IRR
management or ALM policy, safe and sound business practices do.
However, no requirement exists for a separate IRR or ALM policy

independent of other policies, even for large, complex credit unions.
Credit unions have the option of either creating a separate IRR or
ALM policy or incorporating it into Investment, Cash Management,
or other policies. The form of the policy is not as important as its
scope. Regardless of form, credit unions should clearly document
their IRR management program in writing.
The scope of the policy will vary depending on the complexity of the
credit union’s balance sheet. A credit union that offers personal
loans, invests in non-complex or short-term bullet investments (a
debt security that returns 100 percent of principal on the maturity
date), and offers basic share products may not need to create an
elaborate policy. The policy for these credit unions may limit the
loan portfolio maturity, require a minimum amount of short-term
funds, and restrict the types of permissible investments (e.g.,
Treasuries, bullet bonds .)
RegFlex removes the shock test requirement under $703.90 for qualifying credit
unions.
Page 13/24
More complex balance sheets, especially those containing mortgage

loans and complex investments, require a comprehensive IRR
management policy. The policy should establish responsibilities and
procedures for identifying, measuring, monitoring, controlling, and
reporting IRR, and should establish risk limits. Overall, the examiner
should determine the adequacy of credit union policies using the
following guidelines:
Written policies addressing IRR, and containing enough detail for

the appropriate parties (e.g., board, ALCO, ALM program
person, investment officer) to understand the risk limits and their
individual responsibilities. Management should avoid vague
language and boilerplate policies;
0 Reporting requirements providing informative reports to decision

makers in a timely manner. The policies quantify risk limits and
provide for prompt identification of IRR so management can
implement appropriate risk mitigation strategies in a timely
manner;
0 Risk limits for both short- and long-term cash flow horizons
(e.g., both earnings and economic value perspectives, if
appropriate); and
Frequent policy updates addressing the risks inherent in the

current balance sheet. When developing or updating policies,
management should seek input from across the organization (e.g.,
board, ALCO, and operational departments such as lending and
investments.)
The board should review the policies at least annually, and revise as
the credit union makes changes to its business practices (e.g., types
of loans, types of shares, and types of investments), introduces new
strategies, or when the complexity, asset size, or sophistication of
management changes. For example, when a credit union first offers a
mortgage loan product, or offers a mortgage loan product with
significantly different terms (e.g. new balloon product or home
equity line of credit), the board should review the policies to
determine if they address any additional potential IRR.
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EXAMINER'S GUIDE
If possible, the policy should require the credit union to spread risk
management duties among several divisions (e.g., senior
management, lending, cash management, investments, and deposit
activities), or assign them to a committee (e.g., ALCO) comprised of
both credit union staff and board members. This integrates risk
management into credit union operations. Small credit unions with
limited staff and resources can vest these responsibilities with the
manager and the board.
Effective IRR management programs require strong internal controls.

Management must develop internal controls that promote accurate
risk measurement and objective reporting. By separating risk-taker
responsibilities (e.g., investment officer or CEO) from those
responsible for measuring (e.g., ALM program person) and
assessing (e.g., ALCO) risk, credit unions decrease the possibility of
optimistic and inaccurate risk measurement results and,
consequently, inappropriate decisions. If segregation of these duties
does not exist, this shortcoming may lead to high IRR exposure. The
examiner should determine if the policy addresses the internal
controls governing the IRR management process.
Small or non-complex credit unions lacking available resources may

have to concentrate risk taking and risk measurement responsibilities
in a single individual. The board and supervisory committee should
take an active role in monitoring the activities of the individuals. The
board should also limit each individual's authority.
The basis of the IRR measurement should correspond with the

complexity of the balance sheet: gap and simplistic (short-term)
income simulations can suffice for simple balance sheets that
primarily consist of short-term bullet type investments (e.g . ,
Treasury bills or notes) and non-mortgage related assets (e.g., no
real estate loans or mortgage-backed securities .) Credit unions with
more complex balance sheets, including those with complex
investments and real estate portfolios, require more sophisticated
earnings simulations and economic valuation models (e.g., shocked
mortgage and investment [asset] valuation or NEV.) As the
complexity of the balance sheet increases, conducting multiple
measures can prove advantageous since each methodology may
measure IRR differently.
Page 13/24
The IRR management or ALM policy should express IRR measures

and limits in terms of gap, earnings (i.e., net income “I], net
interest income [NII]), net worth (e.g., mortgage portfolio shock,
investment portfolio shock, change in NEV) or a combination of
these. For all but the smallest or simplest credit unions, management
should establish quantitative IRR measures to alert the credit union
of the existence of unacceptable IRR exposure.
While a credit union may use other rate scenarios, and is encouraged
to do so, at a minimum it should apply a +/- 300 basis point (bp)
instantaneous, permanent, and parallel rate shock. Under this rate
shock, the entire current yield curve (both short- and long-term rates)
is assumed to shift 300 basis points from its current position
immediately and without future movements. NCUA considers this a
reasonable stress test.
For additional scenarios, the credit union may apply a yield curve
twist by shocking only a portion of the yield curve, such as short-
term rates, or apply a ramped rate scenario by adjusting the yield
curve gradually over time, generally 12 months. The credit union
may also analyze basis risk by measuring the impact of changing
relationships between indices (e.g., 90 day Treasury bill versus 3
month LIBOR.) The more scenarios the credit union runs, the better
its understanding of potential sources of risk.
For credit unions with complex balance sheets (e.g., mortgages and
complex investments), management should provide IRR measurement
reports to the board no less frequently than quarterly. In cases where
the balance sheet changes frequently and significantly, management
should consider providing monthly reports. The board may receive
IRR measurement reports less frequently if management provides
such reports to an ALCO (preferably, with at least one board
member on the ALCO) and the ALCO alerts the board to significant
events (e.g -,approaching or broaching a policy limit .) Semiannual
board reports may suffice for less complex credit unions.
IRR policy limits, commensurate with the earnings and net worth
position, mean that highly profitable and well-capitalized credit
unions may establish less restrictive limits than those less profitable
or with lower capital. Management should consider the degree of
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EXAMINER'S GUIDE
precision and accuracy of the risk assessment model when

determining acceptability of a risk limit. A sophisticated model that
properly addresses prepayment and other option risks will likely
experience less measurement error; therefore, a looser limit may
suffice. Conversely, if the risk measurement model and depth of
analysis or precision is low, then the credit union should tighten the
risk limits to compensate for potential inaccuracies. Refer to the IRR
measurement section of this chapter for further discussion.
Sample Credit Union Policy Limits for IRR
Basis of measurement IRR Limit
Gap: beyond +I- 20 percent change in any given

period, or cumulatively over 12 months
Earnings Simulation:
NII after shock change > 30 percent over any 12
month period
NI after shock change > 75 percent over any 12

month period
Asset valuation: after shock change in book value net worth

> 50 percent or
after shock value of net worth < 4 percent
NEV: after shock change in market value net worth

> 50 percent or
after shock value of net worth of <4 percent
Table 1
IRR limits exceeding the parameters in Table 1 indicate possible red

flags (all limits assume a +/- 300 basis point instantaneous and
permanent interest rate shock.)
A red flag exists if the credit union exceeds the limits of the IRR
policy. This could signal that (1) the risk assessment methods used
did not adequately identify potential risks, (2) the credit union failed
to take prompt action to reduce the risk exposure, or (3)
management's efforts ineffectively reduced the risks. However, the
possibility exists that unforeseen events caused the credit union to
exceed the risk limits and the credit union actually took prompt
corrective action to mitigate future risk. Examiners should expect
management to explain the underlying causes and the resulting credit
union action.
Page 13/24
Planning and Examiners should review how the credit union integrates the IRR
IRR management process with strategic and financial planning. They
Management should determine if strategic planning occurs at ALCO meetings, or
if planning represents a separate function. Strategic planning
meetings should include the ALCO, who should have an opportunity
to comment on proposed plans. Exclusion of the ALCO from
strategic plan development impairs IRR management integration into
the planning process. Overall, the examiner should review the
following to determine if the credit union adequately integrates IRR
management and planning:
The credit union considers the effect of future events on its IRR
exposure;
The credit union adopts strategic plans after considering the
riskheward relationship. The credit union appropriately analyzes
and measures the IRR associated with new products, services, or
investments;
The credit union includes ALCO and other persons with ALM
responsibilities in the strategic planning process;
The credit union updates IRR policies and risk limits as necessary
and in a timely manner to reflect the projected risk profile;
ALCO minutes document that the committee actively assesses
risk and makes recommendations to the board to mitigate risk or
improve the IRR management program; and
The credit union conducts periodic assessments to compare actual
performance with the plan.
Management may establish new risk limits during the strategic

planning process. If so, management should support its rationale for
the change. If the strategic plan shows significant growth in services,
products, or account balances, the examiner should see an explicit
integration with the IRR policy and associated risk limits.
For example, during the strategic (financial) planning process, credit

unions should consider the effect on balance sheet IRR resulting from
changes to the following:
Share and borrowing portfolio structure (e.g., nonmember

shares, high rate money market accounts, long-term advances, or
insufficient early withdrawal penalties on CDs);
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EXAMINER'S GUIDE
Loan portfolio structure (e.g., longer maturities [ > 5 years],

prepayment risk, or non-conforming real estate loans);
Investment portfolio structure (e.g ., lengthening maturities,

inverse floaters, dual-index floaters, or callable securities); and
Future events forecast by management that may have a material

effect on balance sheet structure and IRR (e.g., merger,
aggressive growth plans, sponsor layoff, or restructure.)
Management should measure the potential effect of projected changes

in balance sheet structure. They should model projected balances or
product (investment) mix changes under different interest rate
scenarios to determine the risk exposure of projected changes.
If credit unions simply adjust product rates in line with market rates,
their IRR management programs should not require significant in
depth analysis. However, balance sheet exposure changes when the
credit union adds products or investments with different:
Maturities (e.g., 20 years versus 5 years);

Cash flow behavior (amortizing/callable cash flow versus a
bullet) ;
Floating rate indices (e.g., Prime versus LIBOR); or
Repricing intervals (e.g., 1-year versus 5-year ARMS.)
If the credit union has implemented a new loan or share program

since the last examination, the examiner should determine whether
the credit union performed due diligence by (1) performing an IRR
analysis that addressed the characteristics of the product, and ( 2 )
documenting its assumptions and analysis. For example,
implementing a mortgage program would require comprehensive
understanding of prepayment risk and proper analysis of IRR.
Similarly, if a credit union currently offers personal loans and
chooses to begin offering home-equity lines of credit (HELOCS), it
must address the effect on the current portfolio of uncertain cash
flows (e.g., draws or prepayments) and other variable rate features.
It must also determine whether the existing data processing system
can properly handle HELOCS.
Page 13/2-10
Effective management of IRR depends on credit unions evaluating

riskheward relationships and setting appropriate limits on new
programs. If the credit union knows about a planned future event
(e.g., sponsor layoff, credit union merger, etc.), it should analyze
the pro forma effect on its financial standing, especially on IRR
exposure. This also applies to credit unions dependent on an industry
experiencing turmoil. Further, credit union mergers can radically
change the continuing IRR profile, if the merging entities have
different asset/liability mixes. Prudent credit unions will conduct pre-
merger risk analyses.
Finally, the credit union should conduct periodic assessments to

compare the actual performance with those forecasted. Self-
assessments of prior projections and plans enable the credit union to
(1) identify inaccurate or unreasonable assumptions or other causes
for discrepancies, and (2) improve the validity of future projections.
Oversight, The ALCO typically provides management oversight and guidance

Monitoring, for the ALM program as a whole, including IRR management. The
and ALCO major responsibllities of ALCO include identifying and monitoring
IRR and developing strategic risk mitigation strategies.
The depth of monitoring necessary for the IRR management program

will depend on the credit union’s size and relative complexity.
Smaller, less complex credit unions with simple balance sheets may
not have (or need) an ALCO. They may only need to determine
whether the balance sheet has changed significantly, and monitor
general ratios (e.g., loan to share ratio, long term assets ratio.) A
semiannual evaluation may suffice for these credit unions. More
complex credit unions should have procedures in place requiring
senior officials to consider the effect of strategic decisions on the
IRR exposure, review risk results and ratios, and determine courses
of action. These complex credit unions should monitor IRR at least
quarterly.
Larger or more complex credit unions should have a well-organized

ALCO with clear, relevant, and concise IRR management
documentation. The examiner should review the composition of the
current ALCO and determine whether members have staff or board
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EXAMINER’S GUIDE
positions. Preferably, at least one board member will sit on ALCO.

This improves communication between the ALCO and the board, and
increases the board members’ knowledge of IRR. The ALCO should
consist of representatives across the credit union’s divisions of
responsibility (e.g . , loan department, investment office, marketing
department, CFO, and CEO) since IRR management decisions affect
the entire credit union operation.
Officials involved with ALCO should have knowledge of the credit

union’s risk position and actual performance compared to stated
objectives. While individual qualifications may vary, the ALCO
members should understand IRR. The complexity of the balance
sheet will influence the desired level of experience on the ALCO.
That is, for simple balance sheets, a basic understanding of interest
rate risk should suffice. For complex balance sheets, the committee
should understand (1) specific sources of balance sheet risk, (2) risk
measurement techniques, (3) risk measurement results, and (4)risk
mitigation strategies.
As the degree of balance sheet complexity increases, so should the

amount of training provided to ALCO members. Timely training
enables members to remain versed on contemporary ideas.
Weaknesses in the IRR management process may signal a need for
training. Examiners may review the level of training provided to
ALCO members since the prior examination.
Overall, the examiner should assess the adequacy of the ALCO’s

oversight of the ALM program by determining if the ALCO:
0 Provides adequate documentation of its discussions and actions,

and demonstrates it meets its prescribed responsibilities;
Understands that IRR risk concepts adequately coincide with the
amount of risk permitted;
0 Comprehends the risk measurement reports so that it effectively
assesses interest rate risk and makes proper recommendations to
mitigate risk;
0 Attends training regularly on contemporary IRR management
issues and risk measurement methodologies; and
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Understands the key assumptions driving the model to ascertain

the accuracy of results and precision of risk measurement reports,
and offers recommendations for improvement.
The examiner may review ALCO minutes, noting whether the ALCO
holds meetings as required by policy. Minutes establish a formal
record of ALCO meetings and member attendance. Lack of minutes
may indicate the ALCO is inactive, does not follow a consistent
agenda in which it evaluates risks, or does not make formal
recommendations to the board.
Examiners should note as a finding ALCO’s failure to meet as

required. By not meeting as required, ALCO not only violates board
policies, but it also fails to monitor risk on a regular basis.
Examiners may want to consider interviewing ALCO members to
determine the extent to which they understand and meet their ALCO
responsibilities.
Examiners should review the types of decisions and discussions

documented in the minutes. For ALCO meetings, the minutes should
evidence that ALCO:
Reviews IRR exposure and compares the results to ALM policy

1imits ;
Develops alternative plans when risk in the credit union
approaches or exceeds risk thresholds; and
Discusses and determines whether the current risk measurement
system adequately evaluates IRR and liquidity risk exposures.
For credit unions with in-house IRR measurement models, this
could include the engagement of an outside IRR vendor or
consultant to test and validate the IRR modeling process.
As a key user of the model’s output, the ALCO must understand the
key assumptions driving the results. While the ALCO need not have
a thorough knowledge of the underpinnings of the model (e.g.,
understanding how the model estimates prepayments on amortizing
accounts), it should have a broad understanding of model
assumptions. For example, it should recognize that mortgage
prepayments would vary with changes in market interest rates (e.g.,
due to the refinancing incentive.) As the key user of the risk
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EXAMINER’S GUIDE
measurement output, ALCO should appropriately determine the

shock scenarios (e.g., applying an instantaneous 300 basis point
shock) and establish the balance sheet forecasts (if the credit union
uses a dynamic balance sheet approach for earnings simulations.)
The minutes should reflect the ALCO’s proactive actions to mitigate

risks before they approach or exceed established limits. If the ALCO
does not take action before risks exceed limits, it is not effectively
directing the IRR management program. Furthermore, the credit
union may miss the opportunity to implement corrective action in a
timely manner (e.g., it takes time to sell loans or arrange for
financing), or to contain the costs involved (e.g., if problems arise,
creditors may rate the credit union as a higher risk, resulting in
higher borrowing rates.) Acting proactively requires the ALCO to
develop alternative courses of action, and prioritize them based on
cost/benefit relationships, long-term effectiveness, and timely
implementation.
The ALCO should understand whether the risk measurement model’s

sophistication is commensurate with the complexity of the balance
sheet. For example, if the balance sheet consists of embedded options
and uncertain cash flows, the ALCO should understand whether the
model could reasonably measure the effect of these characteristics on
the credit union’s IRR exposure (e.g., gap and simplistic income
simulations would not suffice.)
The ALCO must understand if it receives sufficiently accurate and

precise information on which to make informed decisions about the
risk profile of the credit union. Therefore, in addition to evaluating
current risk measurement outputs, it should question whether other
available alternatives could reasonably improve the risk measurement
process (e.g., the benefits justify the costs.) The absence of
recommendations does not necessarily indicate an adequate system or
appropriate output reports. It could signal the AECO does not have
the experience and understanding to make recommendations for
improvement.
Examiners should determine whether the ALCO has developed or

recommended changes that the board did not adopt (e.g., using a
different model, restructuring the IRR management responsibilities,
Page 13/2-14
or adding additional internal controls.) If the board does not respond

to recommendations for improvement from the ALCO, it could
indicate the board does not understand IRR management or does not
embrace it as a management tool.
Examiners can conclude that the credit union does not have an
effective ALCO if it has a weak IRR management process and if the
ALCO did not know of the problems identified during the
examination or supervision contact. Likewise, the ALCO does not
meet its responsibilities if it knows of weaknesses but does not
resolve them.
IRR Credit unions should measure IRR no less often than semiannually,
Measurement assuming the balance sheet does not incur any significant changes
Review (e.g., a rapid growth in fixed rate mortgages, a significantly
lengthened investment portfolio maturity, a new CD program
attracting a large number of member shares.) For federal credit
unions, NCUA Rules and Regulations $703.90 requires quarterly
measurement if complex securities exceed net worth (unless the
credit union receives an exemption under RegFlex provisions.) Less
complex credit unions may employ basic gap and other models,
while larger or more complex credit unions should employ more
sophisticated earnings simulation and/or valuation models, which
they run internally or obtain from outside vendors.
IRR IRR management is a dynamic field that requires frequent updating

Measurement of risk measurement methodologies to reflect current risk
Staff Review measurement techniques Outsourcing the risk measurement process
I_
does not absolve management from understanding the assumptions

driving the results. The complexity of the credit union’s balance
sheet and risk measurement model will determine the need for an
experienced IRR measurement or program person. (Appendix 13A
provides a brief description of IRR measurement tools.) The
experience of the program person may reflect the credit union’s
interest in implementing a strong IRR management program
An effective program person should understand how the model

works, and what key assumptions drive the results. For example, the
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EXAMINER’S GUIDE
program person should understand which assumptions require

changing in order to tailor the model to the credit union (e.g.,
mortgage prepayments and non maturity share runoff.) A program
person with weak skills will more likely produce inaccurate modeling
results, which will demonstrate the need for further training.
Conversely, a talented program person should consistently develop
reasonable risk reports and make recommendations to improve the
risk measurement process.
Training of the program person will help ensure the credit union uses
the program proficiently, better understands the model’s capabilities
and limitations, and accurately measures risk. The initial training
should enable the program person to understand the more intricate
functions of the model. The degree of training needed will depend on
the risk inherent in the balance sheet. A balance sheet consisting of
complex securities and mortgage-related assets necessitates more
intricate risk measures (e.g., NEV versus gap) than a simpler
balance sheet primarily composed of bullet instruments and consumer
loans.
The program person should obtain additional training to stay current

with the changing climate. For example, if a credit union purchased
a model before it implemented a mortgage-lending program, it may
not have used the prepayment function of the model originally.
However, further training on the prepayment capabilities may prove
beneficial because of the mortgage program.
Examiners should review the experience and background of the

persons charged with determining the model assumptions and
interpreting the output (e.g., program person.) They should
determine what training on contemporary IRR measurement concepts
the program person has attended.
Examiners may want to discuss the model’s strengths and

weaknesses with the program person. They should determine the
program person’s level of understanding of the credit union’s risk
measurement model. For example, does the program person
recognize use of model default values and, if so, can the program
person explain the validity of the default values.
Page 13/2-16
Credit unions need backup persons to ensure continuity in the risk

measurement process. The backup should also receive full training
on the model. The examiner should determine if the credit union has
a backup program person, and inquire as to what training the backup
has received on the model used.
Overall, the examiner should determine the following to assess the

adequacy of the IRR measurement program’s ability to generate
sound and reasonable IRR measurement results:
0 Staff‘s familiarity with the assumptions driving the model and

experience with the model’s basis for measurement (e.g.,
earnings simulation or NEV);
Default assumption adjustments (e.g., prepayment rates, non-

maturity deposit runoff rates) that tailor the model to the credit
union. Staff has the institutional knowledge to determine if the
model produces accurate results, and regularly makes
improvements to the model or its assumptions;
Assignment and training of a backup person, who can adequately

use the model without supervision of the program person;
0 Documentation of assumptions to ensure consistent measurement

between periods; and
0 Validation by a third party for reasonableness of model results

for large or complex credit unions.
Review of IRR The credit union’s review of the IRR measurement model should
Measurement ensure that data and assumptions accurately represent its balance
System sheet and risk profile (e.g. accurate input of balance sheet accounts,
rates, and maturities.) By examining the input data directly or testing
the output against a benchmark, a credit union could test the model’s
output. For example, a credit union could benchmark its real estate
loan portfolio valuation against the OTS Pricing Tables, or the
Mortgage Pricing Tables in AIRES.
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EXAMINER'S GUIDE
Someone other than the person running the model (e.g., supervisory
committee, internal/external auditor, supervisor) should conduct the
review of the IRR measurement model. The reviewer of the
modeling system should understand IRR and the risk measurement
system, including the model's methodologies and assumptions. If the
supervisory committee or other credit union personnel assumes this
task, they should attend periodic training on the model.
Internal controls should require documentation of the key

assumptions (e.g., stressed interest rate environment, cash flow
assumptions of non maturity shares) for review by the examiner,
board, and ALCO. Credit unions should rarely make changes in
assumptions, unless they make refinements to improve the
underlying quality of the assumptions (as is likely for prepayments
because prepayment performance changes over time. )
The model reviewer should look for documentation supporting the

underlying assumptions and input, and compare the assumptions to
market trends or performance through industry-recognized
information providers. For example, the reviewer may benchmark
the credit union's prepayment assumptions against (1) generic
prepayment data provided by FNMA, or (2) comparable mortgage-
backed securities as reported by a financial information supplier
(vendor.) Alternatively, the reviewer may benchmark the output
against other available data (e.g., the OTS and NCUA real estate
loan pricing tables to compare valuation results prepared by the
model .) If differences exist, or assumptions appear unreasonable, the
reviewer should ask the model program person to reconcile or
explain the differences.
If the reviewer does not understand the model, this may hamper the
value of the recommendations. Thus, the absence of any
recommendations does not necessarily indicate a problem-free
modeling process. If the reviewer has made recommendations,
examiners should determine whether the credit union acted on them.
If not, they should determine the reasons. Lack of a plausible reason
could signal that the officials have not embraced the value of
accurate risk measurement.
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ALM - INrEREST RATE RISK
Examiners should determine whether the credit union has established

internal controls to ensure the risk measurement input accurately
reflects the credit union's financial data. At a minimum, the credit
union should reconcile or test the data input against the financial
statements to make certain all accounts are in the system. Good
internal controls should prevent the program person from also
assuming risk-taking authority (e.g., executing investments, or
establishing rates on shares and loans.) Certain models provide
diagnostic reports to readily identify implausible assumptions or data
input. (Examiners can refer to the ALM Public Folder for more
information on specific IRR measurement program vendors .)
The examiner should determine who evaluated the reasonableness of

the risk measurement system inputs and assumptions and whether it
was someone other than the program person. The examiner should
ascertain what steps the credit union took to determine the
reasonableness of the input and assumptions.
Examiners should determine if the reviewer made any

recommendations, and if the credit union implemented these
recommendations (especially if the recommendations cover a wide
scope of deficiencies.) Examiners should further determine if the
board and ALCO knew of errors that could significantly
misrepresent the results.
Finally, examiners should determine what steps the credit union has
taken to ensure meaningful comparison of results between periods.
Consistent measurement between periods enables understanding of
the changing risk structure of the balance sheet and identification of
the underlying causes. Examiners should take exception if
assumptions change from period to period without reasonable cause.
The results will likely mislead decision makers (e.g., the ALCO and
board) resulting in inappropriate decision-making . The examiner
should ascertain whether the credit union documents its assumptions,
and makes users of the results aware of changes in key assumptions.
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EXAMINER'S GUIDE
IRR Credit unions can purchase IRR models from vendors, contract with
Measurement vendors to perform the analysis, or develop their own proprietary
Techniques and systems. The source of the measurement tool is not important as
Of Risk
long as the credit union can obtain a reasonably accurate
measurement of IRR, and the credit union understands the
methodologies and assumptions driving the results.
Reviewing a model's capabilities and the assumptions driving a

model requires a comprehensive understanding of the risk
measurement system. This can involve understanding a complex
process. If the examiners find that the degree of model or user
sophistication exceeds their ability to determine whether the model
system reasonably measures IRR, they should consult with their
supervisor to seek additional assistance (e.g., request assistance by
the regional capital market specialist [RCMS] or a capital market
subject matter examiner [CM SME].)
Overall, the examiner should determine the adequacy of the degree

of measurement precision and accuracy, based on use of the model,
not simply its capabilities, as follows:
The basis for risk measurement is commensurate with the

complexity of the balance sheet (e.g., the credit union relies on
sophisticated earnings simulation and economic valuation models
to measure IRR in a complex balance sheet);
The measurement horizon captures the short and long-term risk

embedded in the balance sheet (e.g., the model analyzes cash
flows, earnings, and value over the entire maturity range of
accounts);
0 The model accounts for mortgage prepayments or interest rate

caps when the credit union holds significant portfolios of real
estate loans or floating rate assets;
0 A reasonable degree of accuracy exists because appropriate and

rational assumptions, valid data, and proper cash flow projections
(e.g properly modeling mortgage prepayments) serve as the
~
basis for the results; and

The credit union analyzes its balance sheet performance and

characteristics, and tailors the model’s assumptions to its balance
sheet.
Table 2 illustrates how the examiner can use the credit union’s IRR
measurement tool to determine if IRR exposure is low, moderate, or
high. Examiners should consider the degree of precision and
accuracy of the risk assessment model when determining
acceptability of a risk limit. A sophisticated model that properly
addresses prepayment and option risk will have less measurement
error; therefore, a looser limit may suffice. Conversely, if the risk
measurement report has a low depth of analysis or precision, tighter
risk limits may compensate for potential inaccuracies. All limits
assume a 300 basis point instantaneous and permanent interest rate
shock.
IRR Exposure
Basis of measurement
Gap
% change in any given period
or cumulatively over 12 months +/-lo% +/-10-20% > +/- 20%
Earnings Simulation
NII: after shock change over any
12-month period <20% 20-30% > 30%
NI: after shock change over any
12-month period <40% 40-75 %
>75%
Asset Valuation:
after shock change in book value
net worth <25% 25-50% >
50%
gJ
after shock value of net worth >6% 4-6% < 4%
NEV:
after shock change in market value
net worth <25% 25-50 % >
50%
or
after shock value of net worth >6% 4-6% < 4%
Table 2
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EXAMINER’S GUIDE
IRR Measures The examiner should determine what IRR measurement

methodologies the credit union uses to identify, measure, monitor,
report, and control IRR. For short-term IRR measurement, income
simulation provides more reliable results than gap analysis because it
not only captures cash flows, but also it projects earnings. Gap
analysis may not accurately project earnings because it does not
consider interest rate caps or floors, the current rates earned and paid
on accounts, and the indices driving floating rate accounts (e.g.,
Treasury versus Prime.) Credit unions should set earnings limits to
measure IRR over two years, but preferably over a longer period
(e.g., five years) if the credit union offers mortgage loans and does
not perform economic value analysis.
As the complexity of the balance sheet increases (e.g., the credit

union more heavily invests in mortgage loans and complex
investments), the level of analysis should increase. Gap and simple
income simulation models may suffice for simple balance sheets
(e.g., assets concentrated in consumer loans and non-complex
investments, and funded by member shares .) More sophisticated
earnings simulation models and economic value models (e.g., asset
valuation and NEV) would better serve complex institutions (e.g.,
assets include mortgage loans, mortgage-related investments, or
complex investments, and liabilities may include borrowings .)
NEV and asset valuation analyses measure the change in net worth in
a current and stressed interest rate environment (e.g., under a 300
basis point instantaneous and parallel rate shock.) Both are effective
methods (although NEV can provide more precise results because it
values shares and liabilities) for evaluating IRR over a long-term
horizon (i.em9 from the current period to the maturity of the measured
assets and liabilities.) Asset valuation and NEV measure the credit
union’s current economic solvency and projected economic solvency
under a stressed interest rate environment. These economic value
measures can identify IRR that short-term measures such as gap and
income simulation may not reveal.
Based on the complexity of the balance sheet, the examiner should

determine whether the credit union’s measurement method (IRR
measurement model) appropriately measures short- and long-term
risks. The examiner should review the rate shock scenario used to
Page 13/2-22
measure interest rate risk and determine whether the credit union
sufficiently stratifies assets by type and characteristic. For amortizing
accounts (e.g., real estate and commercial loans, and mortgage-
related investments [CMOS and mortgage pass-throughs]), the credit
union should account for estimated prepayments. Examiners should
determine that prepayment estimates (1) meet reasonableness
expectations, and (2) have supporting documentation. Examiners
should also determine that prepayment assumptions change during
different interest rate cycles.
Examiners should review callable investment cash flows to ascertain

whether they correlate with call dates under falling rate shock
scenarios. By reviewing certificate cash flows, examiners can
ascertain if the model accounts for early withdrawals by members
under rising rate shock scenarios. Examiners should review the cash
flows on borrowings to see if the model accounts for any puts (e.g.,
puttable FHLB advances) by the lender under rising rate scenarios.
Finally, examiners should determine how the credit union treats cash
flows on non-maturity share accounts (e.g., how they assign
maturity.)
Gap Analysis Gap analysis generally excludes consideration of prepayments, call

options, and interest rate caps and floors. Therefore, gap analysis
inappropriately measures IRR if the balance sheet consists of a large
portfolio of mortgages and complex investments. Examiners should
determine if the gap ratio complies with the credit union’s policy
limits. They should review the current one-year gap ratio and
determine whether the credit union calculates gap on a cumulative or
periodic basis.
Income Income simulation models focus on short-term measurement of risk

Simulation (typically less than five years), but can vary in sophistication. More
sophisticated models capture the effect of prepayments, different
floating rate indices (e.g., Prime, COFI, Treasury) and interest rate
caps and floors, and can simulate a multitude of interest rate
environments. If the credit union offers long-term (i.e., 15 or 30
year) mortgage loans, and invests in instruments with maturities
exceeding three years, income simulation models may not adequately
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EXAMINER'S GUIDE
capture the IRR in the balance sheet, since cash flows may exceed
the model's measurement horizon.
Asset Valuation Asset valuation and NEV measure IRR through estimating the
and NEV economic value of financial assets and net worth respectively. These
methods can effectively measure IRR over the entire spectrum of
cash flows, if they also account for the effects of embedded options
within the balance sheet. NEV provides a more complete measure of
risk than asset valuation because it measures changes in liability
values.
Appendices 13A and 13B provide additional discussion and resources

on interest rate risk measurement approaches (i.e., gap, income
simulation, asset valuation, and NEV). Appendix 13C contains a
glossary of ALM terms.
Red Flags Examiners should remain aware of the following potential warning
signs that may indicate a problem in IRR management. Many credit
unions will have some degree of one or two of these elements. These
may not result in safety and soundness concerns. However, if several
of these signs exist, or if they are material, the examiner should treat
IRR management as an area of concern and develop plans to address
the problems.
High level of long-term assets to total assets. The concern is a

high concentration of assets with maturities longer than three
years will reduce the credit union's ability to react to changing
interest rates and expose it to increased interest-rate risk.
0 High level of net long-term assets to total assets. This concern is

similar to that above; however, even a low net long-term asset
ratio does not automatically eliminate the concern about high
concentrations of long-term assets. Even variable-rate loans have
different terms and conditions for repricing that could potentially
present IRR concerns. The examiner should determine that the
indexes, margins, repricing intervals, caps, and floors all provide
sufficient protection against interest rate exposure.
Page 13/2-24
0 Declining net interest margin. This indicates either asset yields

falling faster than the cost of funds or the cost of funds rising
faster than asset yields. Examiners should address both IRR
concerns and should determine whether the credit union has any
options to improve the net margin (e.g., raising loan rates or
lowering dividends.)
Low level of net worth. A low level of net worth, or a level of

net worth that is not keeping pace with share growth, weakens
the credit union 's ability to absorb losses and react to changes.
Rapid share growth or above market dividends. Share growth

that outpaces the ability to generate sufficient net income reduces
the overall strength of the credit union's net worth. Above-
market rates tend to attract less stable rate-sensitive shares. If the
credit union then invests these sensitive deposits in longer-term
assets (e.g. real-estate loans), it creates a mismatch of maturities
for assets and liabilities that could further increase exposure to
IRR.
0 Incremental mismatch of asset and liability maturities. Given the

difficulty of identifying balance sheet interest rate risk at a
specific time, the examiner may benefit from analyzing the
changes in balance sheet structure since the last examination
contact or over the last full year. For example, if a credit union
that did not have a significant long-term asset ratio increased its
share base into more rate-sensitive deposits (certificates of
deposit, money market funds, shares greater than $10,000, etc.)
during the last year, then loaned out these deposits in longer-term
fixed-rate loans, the incremental additions to the balance sheet
may have significant IRR exposure.
The Call Report (NCUA 5300) requests type and maturity

information for loans, investments, and shares. Examiners can
analyze this information to determine if recent product or pricing
decisions create a mismatch. If so, the examiners should discuss
with the officials the potential for emerging IRR concerns before
they become more serious.
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EXAMINER'S GUIDE
0 Lack of I N 3 management or ALM policy. Some credit unions

can operate effectively without a formal policy; however, the
lack of a written policy often indicates that management remains
unaware of the importance of IRR management.
I tltereSt Rate Although examiners should perform a quantitative analysis on every

Risk and examination, the more subjective overall analysis of IRR
CAMEL management in CAMEL depends largely on examiner judgment. The
examiner should keep the size, complexity, and other component
ratings of the credit union in mind when evaluating IRR
management.
Even so, a small "plain vanilla" credit union (shares and loans only)
should have:
0 Strong net worth and stable earnings;

0 Investments with relatively short-term maturities or an acceptable
mix based on share structure and size; and
0 Adequate cash management procedures.
A large, complex credit union offering many different services and

having a diverse share, loan, and investment portfolio requires a
more in-depth understanding of IRR, and a formal (preferably
automated) process to measure balance sheet position and
performance.
If the credit union lacks key elements (e.g., no IRR management

policy or inadequate monitoring mechanisms) the examiner should
expand the evaluation of the adequacy of IRR.
Examiners should develop a DOR with management requiring

establishment (or implementation) of IRR management policies and
procedures within a reasonable period of time, if the credit union
experiences the following:
0 An apparently high amount of IRR;

No IRR management policies or procedures; or
0 Policies and practices having serious inadequacies
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Depending on the degree of apparent risk, the examiner may decide

to plan a supervision contact to ensure compliance within established
time periods. If the credit union’s assumptions or conclusions
regarding IRR exposure appear seriously inaccurate, examiners
should consider including a RCMS or CM SME to assist with this
aspect of the review.
and - Interest Rate Risk Questionnaire (IRRQ) - a supervision tool
References to assist examiners in evaluating IRR. Part D, Step 5 (IRR
Measurement Review) specifically discusses evaluating
measurement of IRR.
References
- NCUA Letter No. 99-CU-12, dated August 1999, Real Estate
Lending and Balance Sheet Risk
- NCUA Letter No. 00-CU-08, dated November 2000, Camel
Rating System
- NCUA Letter No. 00-CU-10, dated November 2000, Asset-
Liability Management Examination Procedures
- NCUA’s Public Folders - Under the ALM Folder (Public
Folders are for Internal Use Only)
Introduction to Interest Rate Risk Modeling - summary
of key components of modeling IRR
Interest Rate Risk Vendor Model Summaries - summaries
of IRR measurement tools (commonly seen in credit
unions) offered by vendors and ALM consultants
Chapter 13 - Part 3
ALM - LIQUIDITY RISK

Examination Determine adequacy of credit union’s liquidity
Objectives Determine demands on liquidity due to current circumstances
Determine whether trends are emerging that may cause future
liquidity demands
Determine whether liquidity management processes sufficiently
allow management to monitor the credit union’s liquidity position
on a current and forward basis
Associated 0 Liquidity risk may occur whenever management cannot satisfy

Risk the cash flow needs and demands for funds;
0 Strategic risk may occur when the credit union takes on a
significant new strategy that could affect the flow of funds (e.g.,
instituting an above market CD to attract new shares or
implementing a real estate loan program); and
0 Reputation risk may occur when the credit union cannot meet
Overview Liquidity management is the process of monitoring flows of funds

and the liquidity of assets to meet demands for funds in the form of
share withdrawals, loan demand, and the operating needs of the
credit union. Management must monitor liquidity and anticipate
future needs for funds. Understanding liquidity requires an
appreciation of it as a matter of cash flow.
Managing Liquidity risk management involves the following:

Liquidity Risk
Identifying the existence of cash flow demands;
Measuring the extent of cash flow demands;
Identifying emerging liquidity demands; and
Taking corrective measures to minimize the liquidity risk and
disruption of member services.
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In smaller or less complex credit unions, management's approach to

liquidity is sometimes very informal, relying mainly on the
manager's knowledge of member deposit, withdrawal, and loan
trends. This informal approach can suffice if the membership,
management, and services offered will probably not change
materially in the short term.
In a larger or more complex operation, the credit union may require

a more sophisticated liquidity analysis, including a more detailed
projection of cash needs. This projection or cash flow budget can
take a variety of forms, but normally, a formal analysis of historical
sources and uses of funds serves as the basis for the projection.
A credit union's sources and uses of funds includes the following:
Sources Uses
- New share deposits - New loans disbursed
- Loan principal payments - Share withdrawals
- Interest income - Operating expenses
- Fee income - New investments
- Maturing investments - Liabilities payments
- Borrowing - Purchase of assets
- Repurchase agreements
- Sale of assets
(i.e., real estate loans
in the secondary market)
- Loan participations
The safe and sound operation of the credit union requires that
management monitor and maintain adequate liquidity. Smaller, less
complex credit unions need not meet the same standards as larger
credit unions; however, each credit union should follow sound
business practices in liquidity risk management..
Examination Examiners review liquidity through quantitative and qualitative

Guidance analyses, including discussions with operational management, to
determine if the credit union can meet member share and loan needs
in a variety of circumstances. If examiners reviewed the 5300 Risk
Parameters in the Scope Workbook (see the Risk-Focused Program
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ALM-LIQUIDITY RISK
chapter for further discussion), they will have an initial indication of

liquidity risk in the credit union. In reviewing liquidity management,
the examiner should:
Review the credit union’s process;

Alert the officials to any noted weaknesses;
Determine that management sufficiently recognizes the overall
significance of liquidity risks; and
Ensure that the credit union maintains a safe and sound process
of monitoring and controlling these risks.
An examiner’s overall assessment of liquidity risk should include an

overview of a credit union’s operations, business plan, management
strategies, and resulting cash flows.
The two main purposes for evaluating liquidity management are:
Risk identification - determine whether any potential causes of

liquidity risk exist; and
Evaluation of management’s control - assess whether adequate
monitoring tools and methods exist to alert management to
emerging liquidity demands in a timely manner.
Liquidity Credit unions should develop and implement a written liquidity

Policies policy (or plan for managing liquidity) tailored to the size and
complexity of the balance sheet, and their susceptibility to cash flow
volatility. Credit unions may incorporate their liquidity management
policies in their ALM or investment policies.
The written policy should clearly establish the purpose, objectives,

and goals of liquidity management. It should clearly set forth how
the credit union will evaluate its liquidity (e.g., ratios, cash flow
projections, minimum cash on hand.) Management should
periodically review and revise, if necessary, the policies and plans to
reflect the credit union’s current tolerance for risk, balance sheet
composition, liquidity strategy, and organizational structure.
Policies should clearly convey to management the board’s tolerance

for liquidity risk. A vague policy that omits risk limits, or provides
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EXAMINER’S GUIDE
limits that would fail to alert management to liquidity demands is

ineffective and indicates the board’s failure to manage liquidity.
In smaller or less complex credit unions, officials should formalize

the policies to ensure adequate management of liquidity risk. The
clarity of these objectives will reflect the credit union’s recognition
and understanding of liquidity risk, and facilitate understanding and
acceptance within the credit union. Credit unions with simple balance
sheets may only need to:
0 Set forth required minimum balances of short-term and overnight

funds (e.g., corporate daily share accounts);
0 Identify alternative sources of liquidity (e.g., lines of credit); and
0 Establish limits in terms of simple ratios (e.g., loan to asset
ratio .)
Larger, more complex credit unions should:
0 Set limits in terms of ratios and projected net cash flows (cash
inflows less cash outflows);
0 Prioritize and periodically test alternative sources of funds;
0 Assign responsibilities for monitoring liquidity; and
Establish reporting requirements.
Policies should clearly define responsibilities to ensure

accountability. For example, the board should establish prudent
policies and limits, and senior management or the ALCO should
implement the policies. The assignment of responsibilities should
cover the detailed operational implementation of liquidity risk
management, including monitoring liquidity, reporting results, and
forecasting future needs
Exceptions to risk limits may constitute a serious violation and

should trigger more frequent reporting and measurement
requirements. Credit union policy should outline the parameters and
time frames for alerting senior management and the board, and
implementing contingency plans.
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ALM-LIQUIDITY RISK
Ratios For purposes of quantitative analysis, several ratios can assist in

assessing the level of liquidity risk at a credit union. The 5300 Risk
Parameters (in the Scope Workbook) uses two ratios to indicate the
initial level of potential liquidity risk: (1) LoandAssets, and (2)
(Regular Shares and Share Drafts)/(Total Shares and Borrowings.)
Credit unions’ quarterly call reports provide the data for quarterly
updates to the 5300 Risk Parameters. The 5300 Risk Parameters
represents one tool that examiners may use in offsite monitoring and
for initial risk assessment.
If the initial risk assessment, examination planning, and scope

development processes indicate a need for further evaluation,
examiners may use the AIRES Liquidity Review Questionnaire
(LRQ) while onsite to help assess liquidity risk and arrive at a final
risk rating. The LRQ contains more extensive liquidity ratios that
will assist examiners in their assessment of liquidity risk. The main
ratios found in the LRQ follow:
Loans/Assets. A credit union should strive to maintain a loan to

asset ratio sufficient to meet member loan demand and still meet
other liquidity needs. A high loan to asset ratio (e.g., in excess of
80 percent) may stress liquidity, especially if (1) the credit union
has limited other funding sources, (2) existing funding depends
on volatile sources (e.g., non-member shares), or (3) the credit
union has minimal short-term investments.
(Borrowings and Non-member Deposits)/(Total Shares and

Liabilities .) Borrowings and non-member shares may indicate the
credit union cannot meet its cash needs through member shares.
Because these funds generally incur a higher cost and more
volatility than member shares (Le., lenders may not renew their
funding if yields do not remain competitive or the credit union’s
financial condition deteriorates), they generally require a higher
level of oversight to manage effectively.
(Cash and Short-term Investments)/Total Assets. This ratio

provides an indicator of how much available cash the credit union
has to meet share withdrawals or additional loan demand. A low
or rapidly declining ratio may indicate the credit union will be
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EXAMINER'S GUIDE
unable to meet its current obligations. Credit unions should

consider the trend in this ratio and determine whether the current
level of cash and short-term investments represent what
management has historically maintained, or whether management
should increase the levels.
(Regular Shares and Share Drafts)/(Total Shares and

Borrowings.) This ratio reflects the level of stable deposits a
credit union has on its balance sheet (as opposed to the level of
volatile funding, which the Borrowings and Non-member
Deposits ratio indicates.) A credit union can reasonably depend
on the availability of these stable funds to meet liquidity
demands.
Other ratios that may indicate liquidity concerns include the

following (the AIRES LRQ contains definitions for these ratios):
Loans/Shares;
Contingent Liabilities/(Cash and Investments);
Net Liquid Assets/(Liabilities and Shares);
Volatile Liabilities/(Cash and Short-Term Investments);
Growth in Volatile Liabilities/Assets;
Investment Loss Ratio; and
Estimated Loan Maturity.
Setting Limits A key step in managing liquidity involves setting acceptable limits.
Limits assist the board and management in determining the adequacy
of the current level of liquidity and alert them to conditions where
liquidity demands may disrupt normal business.
The board should set limits on potentially volatile sources of funds,

such as borrowings, non-member deposits, and concentrations from a
particular source. Prudent policies may esaablish concentration limits
by asset category or cash flow structure, taking into account
maturities and the certainty or uncertainty of cash flows (e.g., due to
prepayments, extensions, or calls.)
Policies will usually express limits as a ratio, or required amount of

funds on hand (i.e., the credit union will transfer funds greater than
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ALM-LIQUIDITY RISK
$X or X percent of assets to the corporate credit union overnight

account.) Ratio analysis may suffice for credit unions with abundant
short-term assets and stable funding sources. Conversely, credit
unions operating under tight liquidity constraints or uncertain cash
flows may require a detailed cash flow analysis.
Alternatively, management may use liquidity gap analysis to project

inflows and outflows of funds for the coming year. In this case, the
policies set liquidity gap targets, which establish ranges or multiple
limits to convey an increasing concern over liquidity demands. For
example, a credit union may set a loan to asset ratio at 75 percent to
trigger formal reporting to the board on a monthly basis, and 80
percent to trigger implementation of an action plan.
Other Measures In addition to quantitative measures, qualitative elements may signal

immediate liquidity concerns. Examples include :
The loan, investment, or share structures have changed

significantly, or significant changes will likely occur in the near
future;
The investment portfolio consists of a significant amount of assets

or liabilities with principal cash flows subject to prepayment or
extension risk;
The credit union has attracted shares or non-member deposits by

paying above market rates; or
0 The credit union has experienced turnover in key management

positions that relate to liquidity risk management.
Monitoring and Credit unions must monitor liquidity and document their analysis.
Oversight Small credit unions with basic share and loan products may perform
an elementary analysis (e.g., reviewing the loan to share ratio or
amount of cash and short-term investments on hand.) Larger, more
complex credit unions should analyze projected sources and uses of
funds, evaluate liquidity alternatives, and determine expected
liquidity under adverse economic conditions.
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A credit union should (1) monitor its liquidity over a timeframe

commensurate with the composition of its balance sheet, and (2)
provide its rationale as to the adequacy of its particular timeframe. A
one-year proforma cash flow would not suffice, for example, if
significant investment or share certificate maturities exceed one year.
Credit unions should also monitor contingent liabilities, which they

may have to fund but have not recognized on their balance sheets.
Most commonly, these commitments consist of unused lines of credit
and credit card balances. Should members begin accessing these
commitments under conditions of limited funding, the credit union
could experience liquidity concerns. Failing to meet commitments
can result in reputation risk and a loss of members.
The board should assign responsibilities for monitoring liquidity to

persons capable of measuring risk, interpreting results, and
presenting plausible and timely recommendations for action (e.g., the
ALCO, or in the absence of an ALCO, a committee of the board, or
senior management.) The background and experience of these
persons should coincide with the size and complexity of credit union
operations and the amount of liquidity risk present. This background
and experience will enable the ALCO to forecast future liquidity
demands, and take preventative action in a timely manner.
Larger, more complex credit unions (generally those greater than

$100 million) should separate the risk measurement and risk taking
duties. This provides a better independent assessment of liquidity and
helps ensure prior decisions do not influence the risk assessment
function. Those charged with risk measurement should report to the
designated senior management official.
Persons responsible for liquidity decisions should meet regularly.

They may have to meet more frequently if crisis conditions emerge
or if the credit union takes on a new strategy that could affect the
flow of funds (e.g., instituting an above market CD to attract new
shares.) Examples of meeting agenda items include but are not
limited to (1) reviewing cash flow projections and the current
liquidity position, (2) evaluating liquidity alternatives, (3)
determining potential future liquidity threats, (4)discussing the
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ALM-LIOUIDITY RISK
impact of future economic events, and (5) recommending changes to

policies and procedures.
Reporting Ultimate responsibility for liquidity risk management rests with the
board. Therefore, management must report existing or anticipated
liquidity concerns in an accurate and timely manner. Early notice of
emerging pressures enables the board to evaluate the cost/benefit
relationship of the various alternatives and initiate action with
minimal disruption in the credit union operations.
Credit unions with complex cash flows or a tight liquidity position

should have detailed reports, possibly consisting of cash flow
projections, ratio results, policy limit comparisons, and expectations
of future liquidity. Smaller, simpler credit unions may only report
the amount of cash and liquid investments maintained and the credit
union's loan to share ratio. The size and complexity of the credit
union should determine the frequency of these reports.
If the credit union has delegated liquidity oversight to a committee

(e.g.? ALCO), board reports may only consist of summary level
data, such as compliance with policy limits. If the board has not
delegated oversight, then the board should receive more detailed
reports from which to make decisions.
Board reports should reflect the credit union's business direction, the
composition of the balance sheet, and the volatility of its cash flows.
The reports should also provide substantive information on which to
make liquidity decisions. For example, reports may indicate liquidity
trends, compliance with board-established limits, and changes in the
credit union's cash flow structure.
Sources of Liability liquidity refers to the credit union's management of its

Liquidity liability and equity funding sources (e.g., borrowings, shares, and
non-member deposits.) When credit unions need to acquire funds
they should obtain funds at reasonable costs and structure the
maturities or cash flows of liabilities to reasonably match against the
uses of funds. The credit union should remain aware of the
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EXAMINER’S GUIDE
composition, concentrations, costs, and characteristics of its funding

sources.
Interest rates and creditworthiness influence the credit union’s ability

to access funding sources (e.g., borrowings.) Therefore, the
availability of certain sources of funds, or availability at reasonable
costs might not exist under all economic conditions. Thus, a credit
union may find borrowings cost prohibitive at a time when its
financial position weakens or the economy experiences rapid
inflation.
Volatility is derived primarily from interest rate competitiveness and

the credit union’s creditworthiness. Credit unions should categorize
funding sources based on their volatility or stability and should have
the ability to defend their decisions. In particular, they should
evaluate the volatility of non-maturity shares (e.g., regular shares,
share drafts, money market accounts), which typically depend on
managerial assumptions rather than empirical data.
Transaction accounts (e.g., share draft accounts) generally do not

experience high rate sensitivity, because members retain these
balances as a means of paying expenses. Conversely, money market
shares and short-term certificates can represent highly volatile
shares. Other volatile sources of liquidity include short-term external
sources (e.g., borrowings and non-member deposits), which are
more sensitive to interest rate risk and the perceived credit risk of the
credit union.
Obtaining a significant concentration of funds from a single source,

especially highly volatile sources such as short-term or callable
borrowings, large dollar deposits, and business deposits, may subject
the credit union to an unsafe level of liquidity risk exposure. Even if
the credit union carefully maintains a competitive rate and sound
credit posture, external factors ( e g legal restrictions, business
decisions) may adversely affect future funding.
Asset liquidity refers to the credit union’s management of its asset

funding sources. Evaluation of asset liquidity depends on the credit
union’s ability to convert assets to cash without loss. For example, it
can convert the most liquid, overnight shares and deposits, to cash
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ALM-LIOUIDITY RISK
immediately and without loss of principal. Cash flows also occur as

investments mature or are called, and through amortization of loans
and mortgage-backed securities. Other means of converting assets to
cash include sales, securitized borrowings, and participation
agreements.
While loan amortizations will provide a steady stream of funds, the

credit union will usually use these funds to support future loans.
Should the credit union not fulfill the member loan demand, it may
disrupt normal operations, affect profitability, and lead to member
concern about the credit union's solvency (i.e. reputation risk.)
Therefore, unless principal pay downs result in excess investable
funds, amortizations may not provide liquidity.
The credit union should manage its investment portfolio to

reasonably match investment maturities or principal pay downs to
potential outflows. Concentrations in maturities provide the same
risk to liquidity as concentrations of cash flow sources. Thus, a
credit union may benefit from staggering its maturities over time.
Investment maturities concentrated in long-term horizons may

especially signal liquidity problems. The classification of an
investment as held-to-maturity (HTM), available-for-sale (AFS), or
trading does not impair its marketability. However, many credit
unions are reluctant to sell HTM securities for fear that the sale will
necessitate reclassification of the entire investment portfolio as AFS
or trading. Thus, if a credit union carries a significant amount of
HTM securities that have an unrecognized loss (e.g., market value
less than book value), it may not willingly sell any security in the
HTM portfolio. This may limit a credit union's liquidity options.
Loans written to secondary market standards have greater

marketability than non-conforming loans. These loans can provide a
significant backup source of funds to a credit union that has a large
real estate portfolio.
Credit unions may also originate loans with the intent to sell them to
increase cash flow. Asset securitization permits credit unions to sell
their consumer loans (e.g . , credit card receivables auto loans, home
equity lines of credit) as a source of liquidity. Besides the underlying
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EXAMINER’S GUIDE
interest rate, the credit quality, as reflected in their delinquency and

charge-off history, will determine the marketability of these assets.
Higher credit quality will result in better prices. Therefore, credit
unions that issue lower quality loans, without compensation in the
form of higher interest rates, may experience significant losses when
selling them.
Cash flow projections may provide greater benefit to larger credit

unions, and those that operate with minimal asset liquidity or rely on
volatile funding sources. Proper projection of cash flows requires
expertise in understanding liquidity, a comprehensive understanding
of the balance sheet structure, and time to construct the analysis.
Credit unions can accomplish this by preparing a spreadsheet, or by
using a maturity gap report (common in most vendor interest rate
risk models.) Examiners should use judgment as to the necessity of
recommending these tools.
The credit union should demonstrate that it made sufficient efforts to

accurately capture cash flows. However, external causes determine
many cash flows, not contracted agreements. For example,
prepayments on amortizing instruments, embedded call options, and
early withdrawals of certificates can affect liquidity. Further, recent
share growth trends may include temporary, cyclical, or other trends
unlikely to continue due to other forces (e.g., flight from equity
investments in a recession.) The credit union should consider the
potential effect of external events.
Though members can withdraw their shares at any time, their actual
behavior may differ considerably. On average, most members retain
a certain balance in their share accounts. Therefore, the credit union
need not maintain cash equal to its regular shares. The effort
required to open an account at another institution may result in
“maturities” for transaction accounts (e.g. , share draft accounts) of
several years. Share draft accounts do not generally fluctuate
significantly with changes in interest rates.
Conversely, money market shares and short-term certificates will

likely experience high volatility, therefore shorter “maturities ” are
appropriate. Short-term external sources of liquidity (e. g ., short-term
borrowings and non-member deposits) also fall within the volatile
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ALM-LIQaDITY RISK
category, because of their sensitivity to interest rate risk and the

perceived credit risk of the credit union. While longer-term shares
and external funds can provide stable sources of funds, the credit
union must consider early redemption options when making this
evaluation.
Credit unions should not assume that business will always continue
as it has in the past. Stress conditions could arise from rising
unemployment, increases in equity investments, or member
dissatisfaction with the credit union's services. These could manifest
themselves in credit deterioration, unusually high interest rate
volatility, reputation risk, and systemic events (e.g., anti-inflationary
monetary policies .) Resulting liquidity demands may extend beyond
what the credit union has available to it through "normal" liquidity
sources (e.g., lines of credit). Therefore, the credit union may need
to explore emergency sources of funds such as loan sales or a
liquidation of other assets.
A third source of liquidity is operating liquidity. A credit union will

experience cash flows from its normal daily operations, as well as
from ongoing business activities. Operating income and expenses
will affect the credit union's liquidity position. Excessive operating
expenses can affect a credit union's liquidity on an ongoing basis.
Marginal profitability results in a reduction of a credit union's cash
flow from income.
The oversight of liquidity should include consideration of the sources

of, and causes of demands on liquidity, from all its points of origin.
There is no substitute for thorough analysis of each contributing
factor in liquidity because, in most cases, liquidity pressures arise
due to multiple causes occurring simultaneously.
Backup Sources Credit unions should educate themselves regarding alternative

of Liquidity backup sources of funding to those that occur within the normal
course of operations. All credit unions should establish at least one
means for generating cash or funding liquidity needs outside of
normal operations. Typically, a credit union will establish a line of
credit with its corporate credit union or another lender (e.g., FHLB.)
Whatever the source, quick accessibility and reasonable cost are
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EXAMINER’S GUIDE
important. The credit union should have demonstrated its ability to

access the source. For example, if a credit union has not sold loans
in the past, it should not anticipate using loan sales as a primary
source of liquidity.
The credit union should remain aware of recent trends, future events,
or management decisions that may have a material effect on the
balance sheet’s liquidity structure. Examples would include (1) new
loan, share, or investment strategies; (2) merger; (3) aggressive
growth strategies; or (4) declining trends in asset quality.
Activities The examiner should understand that the maintenance of adequate

Affecting liquidity and the management process to monitor liquidity are vital to
Liquidity the safe and sound operation of a credit union. Smaller credit unions
need not meet the same standards as larger credit unions; however,
each credit union should follow sound business practices in liquidity
risk management.
The following activities of a credit union’s operation are important in

the assessment of liquidity:
Borrowed funds;
Repurchase agreements;
Non-member deposits;
Real estate and other loan sales; and
Loan participations.
Borrowed Funds Credit unions should plan borrowings for a specific purpose that
management can reasonably explain. When the credit union borrows
funds, they should document a plan for repayment of the funds.
Management should understand all terms of the borrowings,
including call features, prepayment penalties, and debt covenants.
Generally, examiners should accept preplanned borrowing for a

specific purpose or strategy. For example, a credit union may
borrow on a long-term basis to fund real estate loans. Properly
structured, this reduces the liquidity risk resulting from funding
long-term assets with short-term liabilities However, frequent,
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ALM-LIQUIDITY RISK
chronic, and unplanned borrowing may evidence liquidity problems.

Prepayment penalties, embedded call options, and other indentures
may preclude borrowing as an effective liquidity management tool.
(Appendix 11A contains definitions of embedded options and
indentures .) Borrowing subjects the credit union to potential
volatility because interest rates and the creditworthiness of the
borrower can influence lenders.
Examiners should consider short-term borrowings highly volatile

sources of funds. Concentrations of these funds could subject the
credit union to liquidity demands in uncertain economic times, or if
the credit union’s credit standing deteriorates. Longer-term
borrowings generally provide a stable source of funding, although
the credit union may incur a premium cost. Embedded call options
can reduce the stability. Further, the credit union may be precluded
from prepaying borrowings at opportune times (e.g., to refinance at
a lower rate, return the funds due to excess asset liquidity.)
Repurchase Borrowing repurchase agreements (repos) provide an alternative

Agreements source of funds that may cost less than lines-of-credit. However,
sales or early redemptions of repurchased investments may have
significant limitations that prevent collateral sales from serving as a
liquidity source. The credit union must execute a master repurchase
agreement before it can participate in repurchase activities. Legal
counsel should review the agreement before the officials agree to its
terms; therefore, the credit union should execute the master
agreement before potential liquidity needs arise. If the credit union
has not executed the agreement, borrowing repurchase agreements
may not provide immediate sources of liquidity.
The credit union must have available high-grade investments

(typically, short-term Treasuries and agencies) to engage in
repurchase activities. Otherwise, a broker/dealer will not accept the
collateral or will charge a higher ‘haircut’ (excess collateralization-
typically the collateral to book value is set at 102 to 103 percent for
Treasury and agency securities, and possibly higher for other
instruments.)
Page 13/3-15
EXAMINER'S GUIDE ~~
Non-member Non-member shares can provide the credit union with a liquidity
Deposits source that it can tap quickly. However, these funds may require a
higher dividend rate than member shares to entice institutional
investors (e .g ., other credit unions .) Further, these shares generally
have high rate sensitivity and a strong likelihood of their withdrawal
exists should alternatives offer better returns. Thus, these shares may
not provide a low-cost, long-term funding source. Accordingly, the
credit union should develop a plan to address the increased funding
costs and high volatility associated with these shares. Failing to do so
may result in depressed earnings and future liquidity shortfalls.
Examiners should consider short-term non-member deposits highly

volatile sources of funds. Concentrations of these funds could subject
the credit union to liquidity demands in uncertain economic times or
if the credit union's credit standing deteriorates (especially if the
deposit exceeds the insurable amount).
Real Estate and If the credit union has not engaged in a loan sale, it may not
Other Loan Sales recognize the administrative and procedural requirements to
complete the sale (i.e., meeting secondary market standards.)
Arranging mortgage sales generally involves the buyer, thus
precluding sales from being an immediate liquidity source. In
addition, prices will vary based on the underwriting quality (e.g.,
meeting secondary market standards), transfer of servicing rights,
current market rates, and selling loans with and without recourse (the
ability of the buyer to return the asset to the seller.) Thus, experience
in selling loans could increase the credit union's awareness that
liquidity may come at a significant cost.
If the credit union has not engaged in prior sales, it may not
recognize the potential for losses on loan sales. Accordingly, loan
sales may not serve as a realistic source of liquidity, especially if the
loan portfolio consists of low coupon mortgages, or the loans were
not written to secondary market standards. Credit unions that
regularly engage in mortgage lending may have established a
mortgage pipeline with the secondary market (e.g., FNMA,
FHLMC) to facilitate loan sales. Typically, credit unions that sell
loans, sell them on a monthly basis (FNMA and FWLMC set
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ALM-LIQUIDITY RISK
minimum sales requirements.) If the pipeline is well managed, loan

sales can provide a reliable and cost effective source of liquidity.
Recourse refers to the right of the loan purchaser to recover against

the credit union, typically from default by the borrower. If the credit
union sells a loan with recourse, the purchaser can choose to recover
the losses from the credit union rather than from the borrower.
Loans sold with recourse can adversely affect a credit union's
liquidity because the participating organization may seek a refund of
its entire investment. Accordingly, the credit union should closely
monitor the performance of loans sold with recourse to project future
cash flows.
Loan Loan participation represents another potential source of liquidity for

Participations credit unions. This can and often does include non-real estate loans,
such as signature or vehicle loans. Typically, participation involves
an agreement between two or more credit unions or other types of
financial institutions, and includes a pool of loans. A written
agreement should document the transaction and its details, including
the identification of the loans involved. Credit unions should have
the agreement reviewed by legal counsel, prior to implementation.
In this type of liquidity source, the selling credit union would retain
a percentage of the loans, usually 10 percent or more. They would
also retain servicing. Thus, the transaction remains transparent to the
member. The agreement should include details about (1) whether the
sale is with or without recourse, (2) whether buy-back provisions
(rider) exist and the timeframes for such provisions, (3) whether the
seller can repurchase the balance of the loans at a later date should
their level of liquidity increase, and (4)what if any compensation the
seller would receive for servicing the loans. As consumer loans have
a shorter life and require less servicing, the liquidity afforded
through the participation may overshadow the compensation in
importance.
Many, but not all, loan participations occur after origination of the
loans. Larger credit unions might participate on a large loan to a
commercial member to share the risk. A smaller credit union might
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EXAMINER'S GUIDE
use a participation in order to grant real estate loans or loans over

their limit to their members.
and - Liquidity Review Questionnaire (LRQ)
References 0 References
- NCUA Letters to Credit Unions
NO. 02-CU-05
NO. 00-CU-13
Page 13/3-18
INTEREST RATE RISK MEASUREMENT TOOLS -
APPENDIX 13A
GAP A traditional GAP analysis alone does not adequately permit
evaluating mortgage-related risks. A repricing GAP represents a
measure of the mismatch between the amount of assets and liabilities
repricing within a defined time period. It is a simplistic
determination of the relative interest rate sensitivity of a balance
sheet. GAP analysis can adequately pinpoint large mismatches in
assets and liabilities, but lacks as a tool for measuring the complex
variables associated with mortgages. GAP does not consider changes
in the shape of the yield curve, changes in the spread relationship
between different market rates, or option risk (e.g., prepayments). In
addition, it does not address the effect of an adverse increase in
interest rates on net worth.
Income An income simulation model is one means available to simulate the

Simulation effect on net interest income resulting from (positive and negative)
changes in interest rates of 100, 200, and 300 basis points. Typical
models use rate shocks to measure the effect on earnings. Income
simulation represents an accounting-based earnings approach and can
provide useful information for projecting the risk to near-term future
earnings and for strategic planning purposes.
Income simulation offers the following improvements over GAP:
0 Plots all estimated cash flows;

a Captures actual timing of cash flows; and
0 Can accommodate repricing assumptions, amortization
assumptions, and yield curve assumptions.
If a credit union limits its ALM analysis to an income simulation

model, it should extend the analysis to five years. This provides one
way to estimate the effect of embedded options in outlying years. For
example, the credit union may own a security that is callable in the
second year. If the issuer calls the security, the credit union may
have to invest the proceeds at a lower rate; and thus, could cause the
Page 13A-1
EXAMINER’S GUIDE
credit union’s income to diminish in the second year. The income

projection should capture such outlying effects.
However, income simulation makes it difficult to accurately measure

the full exposure of prepayment or option risk. In addition, it does
not fully address the effect on net worth (value). Income simulation
depends highly on assumptions. The longer the time frame, the more
these assumptions influence the results. Users must specify what will
happen to all the cash flows they receive in future periods. They
must incorporate their reinvestment decisions. In short, user bias can
increasingly affect the results.
In addition to measuring the short-term effect of interest rate changes

on income, it is equally important to measure the long-term effect on
capital. Just as changes in interest rates will cause stock and bond
prices to fluctuate, changes in interest rates will also affect the fair
value of the credit union’s balance sheet. As noted earlier, an
increase in interest rates will typically cause a credit union’s existing
loans (and investments) to decline in value. The present value of the
balance sheet represents an estimate of the fair value of your credit
union’s future earnings over the life of the holdings (long-term
measure). Credit unions should understand this relationship. NCUA
expects credit unions with greater risk to have more sophisticated
techniques for quantifying this relationship on their balance sheets.
Managing value in relation to risk will increasingly become more
important and significant as NCUA implements the system of
“prompt corrective action (PCA), as promulgated by the Credit
”
Union Membership Access Act.
Asset For credit unions lacking advanced ALM models, there are
Val uation additional methods for measuring interest-rate risk in mortgage
loans. Using mortgage-backed securities as a proxy, credit unions
can obtain estimates of risk exposure on their mortgages. One public
source of this information is The Asset & Liability Price Tables on
the Office of Thrift Supervision Website at
http://www .ots.treas.gov/quarter.html.These tables provide
mortgage pool security prices at 100, 200, 300 basis point shock
scenarios. Industry recognized information providers also provide
estimated price sensitivity of individual securities.
Page 13A-2
IRR MEASUREMENT TOOLS - APPENDIX 13A
Net Economic Net Economic Value (NEV)’ measures the effect of interest rate risk
Value on capital. NEV represents a solvency measure, but it also estimates
the balance sheet’s future earnings capacity. It measures the balance
sheet’s value at a fixed point in time. Proper NEV models capture
principal and interest cash flows and provide an analysis of option
risk. Managing NEV reduces the volatility of earnings and net
worth.
In short, NEV equals the fair value of assets minus the fair value of
liabilities. NEV calculations must also include the value of embedded
options. Models that calculate NEV compute the value of capital
under current interest rates (no rate change) and then under a
“shocked” interest rate scenario. The variance between these two
NEV calculations represents the potential impact on capital if rates
were to change. The components of NEV are as follows:
Net Economic Value:

A The value today (present value) of future amounts the credit union will
receive such as loan principal and interest payments, and investment
principal and interest.
I-R I
Minus: The value today (present value) of future principal and interest
amounts the credit union will pay for its funds.
I = c I Equals: Net Economic Value.

To compute the present value one must move backward in time from
the future cash flow amounts, using a process called discounting.
The concept of discounted cash flows represents a basic financial tool
that comprehends the relationship between interest rates and fair
value. The discounted cash flow computation serves as the basis for
many cash flow comparisons and ALM analyses. Please see
Appendix 13B for a basic example of discounting future cash flows.
Both credit unions and examiners should understand that variable-

rate assets are not free of interest rate risk. Variable-rate loans or
securities may contain lifetime and periodic “caps” that limit their
ability to increase (reprice) loan rates. In addition, some interest rate
coupon formulas on variable rate loans or securities are contractually
For a more extensive discussion of net economic value and the risk of mortgage-
related assets, see the NCUA Corporate Examiner’s Guide under Reference
information at NCUA’s Website at http://www.ncua.gov.
Page 13A-3
EXAMINER'S GUIDE
tied to a reference rate that may experience infrequent or

unpredictable changes. The modeling of such instruments requires
more complex and robust analytical techniques. In all cases, credit
unions must employ an ALM methodology commensurate with the
risk types and levels assumed.
Page 13A-4
DISCOUNTING CASH FLOWS -APPENDIX 13B
Discounting The following example demonstrates how a change in interest rates
Cash Flows can affect the fair value of a security or loan. Present value is the
Example amount of money an individual must invest today to realize a future
amount.' In other words, it is today's value of the dollar amounts the
recipient will receive in the future. Discounting refers to the process
of computing a present value. Accordingly, present value represents
the discounted value and the interest rate used is often called the
discount rate. The price of any financial instrument (e.g., mortgages
or investment securities) is the present value of its future cash flows.
Understanding the process of discounting cash flows can aid a credit
union in valuing its balance sheet and in interpreting the results of its
ALM model.
Present value of a future value (cashflow amount) N years from

now:
Present Value =
Future Value (Cash Flow Amount) X 1
(l+i)N
i = annual interest or discount rate N = number of years
(See below for formula to accommodate periodic compounding of interest.)*
This example applies the formula to a fixed-rate security. It first

discounts the cash flows at the coupon rate (7.5%)and then again
three hundred basis points higher (10.5 %).
This discussion follows, for example, a chapter on Present Value in Fixed Income
Mathematics; Third Edition by Frank J Fabozzi; (Irwin Professional Publishing;
1993); pp. 19-33.
Present value of a future value n periods from now assuming periodic
compounding:
Present Value = Future Value X 1
(1 + i/m)""
m = Frequency of compounding (e.g.? monthly = 12, semiannually = 2);
i -= Periodic interest or discount rate [annual interest rate (in decimal form);
n = Number of periods [number of years].
Page 13B-1
EXAMINER'S GUIDE
Amount: $1 000 000 Life: 3 Years
Note that the present value of the 7.5 % coupon bond equates to its
face amount of $1,000,000 when the cash flows are discounted at the
7.5% coupon rate. This would equate to a no rate change or base
case scenario when computing NEV. However, the present value
decreases by about $74,000 when the cash flows are discounted at
10.5% . This would approximate a potential 300 basis point rate
shock when computing NEV. The decline in value underscores how
an increase in market interest rates can reduce the fair market value
of a security or a loan. This diminution also represents potential
changes to capital under a NEV rate shock scenario.
While this discounted cash flow example is very basic, it is the

fundamental concept behind what an ALM program does to compute
NEV. NEV models become more detailed when the user adjusts
discount factors for credit, option and liquidity risks.
Page 13B-2
GLOSSARY OF ALM TERMS - APPENDIX 13C
ALM Definitions
This section defines some terms commonly used in ALM. Standard
dictionaries do not contain the definitions of many words and phrases
used when discussing ALM; therefore, this glossary may assist the
examiner in understanding specialized industry-specific words.
(Appendix 12A contains investment terms .)
Basis Risk: the risk to earnings and economic value when a change in one interest
rate differs from that of another interest rate for a similar maturity or term. For
example, the rate on a money market share account typically changes less than that
of an overnight investment account (earning a Federal funds rate .)
Core Share Deposits: in gap analysis, the estimated portion of deposits that are not
rate sensitive. Cores share deposits reflect management’s judgment of the portion
of shares not expected to be withdrawn and reinvested in a higher rate instrument,
in response to an increase in market interest rates. Credit unions may consider
many regular share accounts with relatively small balances, as well as the portion
of share draft accounts reflecting transactional balances, to be core share deposits.
Generally, money market share accounts and share certificates are less likely to be
considered core share deposits.
Discount Rate: an interest rate used in a model to calculate an estimate of fair

value of a financial instrument. A discount rate is used to compute a present value
of a cash flow.
Duration of Equity: a simple estimate of the percentage change in fair value net
worth for a one percent change in interest rates. See the Investment Chapter for a
definition of duration.
Gap Analysis: a simple interest rate risk measurement technique that reports the
mismatch between rate sensitive assets (RSAs) and rate sensitive liabilities (RSLs)
over a given time period. Common time periods (or gap buckets) are 3 months, 6
months, and 12 months. A gap report typically shows differences between RSAs
and RSLs for various gap buckets (i.e., the periodic gaps), and the aggregate
difference between RSAs and RSLs up to a specified time period, such as 12
months (i.e., the cumulative gap).
Static gap analysis shows repricing mismatches based on the current balance sheet
position. In contrast, dynamic gap analysis shows repricing mismatches based on a
forecasted balance sheet. Since many credit unions use gap analysis, examiners
need to understand its uses and weaknesses. Refer to Appendix 13A for further
discussion of gap analysis.
Income Simulation: an interest rate risk measurement technique used to estimate

earnings exposure to changes in interest rates. Credit unions use income simulation
to forecast Net Interest Income (MI), Net Income (NI), and accounting net worth
Page 13C-1
EXAMINER’S GUIDE
under different interest rate scenarios. Refer to Appendix 13A for further
discussion of income simulation.
Index: the market interest rate (to which a margin may be added) that is used to
reset the interest rate on a variable-rate loan.
Interest Rate Risk (IRR):the risk to a CU’s financial condition resulting from
adverse changes in interest rates. IRR is a type of market risk. Exposure to IRR
can be measured by assessing the effect of changing rates and prices on either the
earnings or economic value of an individual instrument, a portfolio, or the entire
institution.
Net Economic Value (NEV):an interest rate risk measurement technique used to
measure the economic exposure of net worth to changes in interest rates. NEV
equals the present value of assets less the present value of liabilities. Refer to
Appendix 13A for further discussion of NEV.
NEV Volatility: measures the change (either in dollar or percentage terms) in NEV
from a base case resulting from a change in interest rates. A high level of NEV
volatility reflects a high level of interest rate risk.
Prepayment: the early repayment of principal, in advance of scheduled

amortization or maturity.
Pricing: a credit union management action to set interest rates and terms on loan
and deposit products offered to members.
Rate Ramp: is a gradual increase in interest rates over a specified time period,
usually 12 months. Rate ramps are used for management forecasts of future
earnings in income simulations.
Rate Sensitivity, Rate Sensitive Assets (RSAs), and Rate Sensitive Liabilities
(RSLs): in gap analysis, the degree to which a financial instrument is expected to
reprice within a given time frame.
For example, given a 12-month time frame for a gap report, a 5-year-remaining-
maturity Treasury note is not “rate sensitive” since it will not mature within 12
months. A credit union can estimate prepayments on consumer loans (e.g., 30-year
mortgages) to schedule the rate sensitivity of its cash flows. Rate sensitivity
assumptions for administered rate liabilities (e.g., regular shares and money market
shares) can be very influential on reported gap results.
Rate Shock: is an immediate change in the level of interest rates. Parallel rate
shocks of 1 to 3 percent are often used to assess interest rate risk.
Repricing: the change in interest rate resulting from either an interest rate resef on
a variable-rate or administered-rate instrument, or a reinvestment of cash flow from
a maturity, scheduled amortization, prepayment, or early withdrawal of an asset or
liability.
A variable rate loan reprices on its interest rate change date and on its maturity
date, when the principal can be reinvested at a current market interest rate.
Repricing also occurs when a credit union administers a rate change on an account
such as a money market share account. A fixed rate loan reprices as scheduled
Page 13C-2
GLOSSARY OF ALM TERMS-APPENDIX 13C
payments occur, upon prepayment of principal, and on its contractual maturity date
when any outstanding principal balance is repaid.
Shocked Value: is a fair value for a financial instrument given a rate shock. The
difference between the current value and the shocked value informs management of
the price sensitivity of a financial instrument to a change in interest rates.
Volatility: can refer to how much change there is in measures of interest rate risk,
such as forecasted net income or NEV, across different interest rate scenarios.
Volatility also can refer to how much market participants expect interest rates or
prices to change in the future.
Page 13C-3
Chapter 14
SHARE STRUCTURE
TABLE OF CONTENTS
SHARE STRUCTURE.................................................................................................... 14. 1

Associated Risks ................................................................................................... 4-1
Overview.............................................................................................................. 14-1
Examination Procedures ...................................................................................... 14-2
Share Draft Programs ................................................................................ 4-2
Operational Flow ..................................................................................... 14-3
Sound Operation ...................................................................................... 14-3
Overdrafts ................................................................................................ 14-3
Verification .............................................................................................. 14-4
Fees ........................................................................................................... 4-4
Business Share Accounts ........................................................................ .l 4-4
Fraud and Forgery ................................................................................................. 4-5
Internal Control Structure .................................................................................... 14-5
Advertising and Disclosures ..................................................................... 4-6
APPENDIX 14A - TYPES OF SHARE ACCOUNTS.................................................... 14A-1
APPENDIX 14B - SHARE ACCOUNT RED FLAGS ................................................... 14B-1
Chapter 14
~ ~~~~
SHARE STRUCTURE
Examination Determine whether the credit union has a realistic share product
0bjectives mix and pricing policy
0 Determine whether the share program meets the needs of the
members
Analyze the share mix to determine whether it provides for
adequate earnings
Determine whether the share program incorporates adequate
internal controls
Evaluate the reasonableness of fluctuations in the shares and share
mix
Determine whether the share program meets all legal requirements
Associated Interest rate risk - improper pricing of products constitutes the

Risks leading cause of interest rate risk;
Liquidity risk - improper pricing and poorly timed duration can
cause liquidity risk;
Reputation risk - improper pricing and product mix, and illiquidity
can result in reputation risk;
Strategic risk - ineffective planning of the share product mix and
pricing policies can result in strategic risk;
Credit risk - allowing members to overdraw accounts can result in
credit risk to the organization;
Transaction risk - improper transaction processing and controls of
share account types and processing failures can cause other risks
(e.g., interest rate risk, liquidity risk); and
Compliance risk - inadequate or ineffective compliance policies
regarding account disclosures for interest rates, yields, or terms can
result in loss exposure.
Overview Share accounts are the primary source of funds for credit unions. As
such, the share program should conform to the credit union's asset
liability management policies. In determining the proper share mix, the
credit union must consider the cost of funds, the matching of funds
Page 14-1
EXAMINER'S GUIDE
with corresponding assets, and the needs of the members. Management

must monitor the share structure and make appropriate changes in a
timely manner when needed.
The extent of the examiner's analysis depends on the complexity of the

credit union's share structure. The examiner considers such factors as
the following:
0 Share policies (i.e., terms, dividend rates, fees, etc.); and

Effect of the share policies on net income, short- and long-term
goals, and funds management.
When examiners have concerns with the share program, they should
perform sufficient procedures to address and resolve their concerns.
Examination Most information systems provide management reports at the end of

Procedures the members' trial balance. Although the number and types of reports
vary with each information system, these reports should enable the
examiner to verify the share account balances and confirm the
breakdown of share types.
Share Draft Examiners may review share draft programs to determine the extent of
Programs the credit union's control over share draft processing, balancing, and
posting. Credit unions must promptly (at least daily) review and
process overdrafts and related loan advances, and clear processing
exceptions. Examiners should expand their analysis when they
encounter or have reason to suspect material risk factors.
Material operational problems (e.g., out-of-balance individual share

draft ledgers, failure to promptly post share drafts, out-of-balance bank
settlement accounts, and lack of proper control over overdraft activity
including exception processing) can prevent a credit union's share draft
program from functioning properly. Because share draft programs
involve third parties, a credit union's failure to properly maintain
internal operations over this program could damage its reputation
resulting in increased reputation risk. Delays in processing drafts
received for payment can increase credit risk and result in material
losses.
Page 14-2
SHARE STRUCTURE
Operational Flow With share draft programs, members write drafts and present them to
third parties, who present the drafts received to their own banks. The
payee's bank forwards the drafts through bank clearing channels for
presentation to the credit union's payable-through bank. The payable-
through bank receives the drafts and makes provisional payment
subject to payment or dishonor by the credit union. Upon receipt of the
drafts, the payable-through bank presents the information on the drafts
to the credit union. Normally, the payable through bank converts the
information on the share drafts to an electronic medium (magnetic
tape) transmits it to the credit union for payment or dishonor (the bank
may also transmit the information directly to the credit union's
information system process supplier.) The credit union then approves
payment and posts the share withdrawals to the members' accounts.
Sound Operation It is the board of directors' responsibility to establish sound operational

and internal control procedures to safeguard the integrity of a share
draft program. A credit union should obtain a written legal opinion that
the program not only conforms with federal law and regulations, but
also any state law requirements or other requirements, such as clearing
house rules. A credit union may use its own routing and transit number
(payable-at method) or the routing and transit number of the payable-
through bank (payable-through method.) The board of directors should
evaluate the cost and conveniences of the two methods before selecting
one.
Overdrafts When a credit union receives a share draft that overdraws a share draft
account, it has several options available:
0 Return the draft as not paid for lack of sufficient funds.
0 Accept the draft pending receipt of payment from the member to

cover the overdraft. This is rare and usually involves small
overdrafts. Credit unions should establish sufficient internal
controls to prevent abuse.
Accept the draft and create an overdraft, and then clear the
overdraft by a transfer from another share account or by an advance
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EXAMINER'S GUIDE
from a line of credit, special loan plan or other arrangement

established with the member.
Credit unions that offer a line of credit for share draft accounts should
ensure the member signs separate agreements: a line of credit
agreement and a share draft agreement. The credit union must comply
with any provisions for lines of credit in the NCUA Rules and
Regulations. The share draft agreement may authorize the credit union
to transfer the amount of loan advance to the share draft account.
Verification Credit union officials do not normally review the share draft to
determine if the member signed the draft presented. Members review
the periodic statement for unauthorized drafts. If members find an
unauthorized draft, they must notify the credit union.
When a credit union receives notice of an unauthorized draft, the credit

union should retrieve the original draft or a copy of the original draft
for comparison against the signature card on file at the credit union's
office. The board of directors should determine that adequate insurance
coverage exists for forged drafts.
Fees Credit unions offering share drafts to their members may charge
periodic fees or service charges to their members using share drafts
(e.g., for the distribution of interim statements, processing stop
payment orders, overdrafts, obtaining copies of paid drafts for a
member, and the actual cost of each member's blank share drafts.) The
board of directors establishes the fee structures.
Business Share For credit unions offering business share accounts, examiners should
Accounts assess the materiality of these accounts on overall operations.
Examiners may need to expand the scope of the examination in this
area based on the following:
0 Numbers and amounts of the business share accounts;

0 Degree and effectiveness of internal controls surrounding these
accounts; and
0 Increased risk resulting from offering these shares.
Page 14-4
SHARE STRUCTURE
Determining the materiality of business share accounts may require

that examiners review more than just a one-day balance of the
accounts. If the credit union does not have available average daily
balances, the balances for multiple periods, such as monthly or
quarterly ending balances, may give a better insight as to the activity
and materiality of these accounts in relation to total shares.
Business share accounts can increase the likelihood of Regulation D

and Bank Secrecy Act violations. Examiners should ensure credit
unions have in place the proper corporate resolutions supporting
signature authorizations for business accounts.
Appendix 14A discusses various types of share accounts credit unions

can offer.
Fraud and Expertise in fraud and forgery detection is beyond the examiner’s role.
Forgery However, if red flags indicate a potential for forgery, examiners should
consult with their supervisory examiner to discuss expanding the
examination scope. Appendix 14B contains red flag indicators for
share accounts.
Forgery of members’ shares involves falsely and fraudulently altering a

member’s share account to one’s own use. Establishing proper internal
controls over share transactions reduce the opportunity for fraud on
members’ shares.
Management should develop and implement a fraud policy. The board

of directors should adopt the policy and require that staff give written
acknowledgment of receiving and reviewing the policy. A fraud policy
sends a signal that officials will not tolerate forgery and other improper
acts. The board can also request its bond carrier to conduct a risk
management analysis audit. The risk management auditor may
recommend additional internal control measures to deter fraud and
forgery.
Internal The board of directors bears responsibility for establishing internal

Control controls over share transactions. Those internal controls include
Structure administrative controls to establish clear lines of authority and
Page 14-5
EXAMINER’S GUIDE
segregation of duties to handle share transactions. Effective internal

controls also include accounting controls to ensure accurate and timely
share transaction posting.
Credit unions should view the internal control structure as a

mechanism to prevent fiaud and detect errors, as well as protect the
credit union and its employees. Member confidence in the credit
union’s safety and soundness could diminish if management or staff
has manipulated members’ shares. The existence of fraud can result in
high or increasing risk and a major area of concern. Credit unions rely
on good member relations; however, small credit unions, where
members personally know management, often depend heavily on
member confidence.
The supervisory committee’s responsibility includes reviewing the

adequacy of the internal controls to safeguard members’ share
accounts. The supervisory committee should promptly investigate
complaints and generate a written report on its findings.
The supervisory committee or internal auditor should document the

review of testing the validity of share accounts. The audit steps may
include the following:
0 Reviewing insiders’ statements of accounts for unusual deposits

and withdrawals;
0 Reviewing the check register for unusual withdrawals (i.e.,
withdrawals of inactive accounts);
0 Reviewing dormant account reports for validity of transactions;
and
0 Reviewing canceled checks for unusual payees, unusual dollar
amounts, or questionable endorsement signatures.
Some credit unions may transfer undeliverable and returned account

statements to a dormant share account status. Unless staff reviews
dormant account activity regularly, this practice may present a
significant risk for fraud.
Advertising and A federal credit union must accurately represent the terms and
Disclosures conditions of its share, share draft and share certificate accounts in all
Page 14-6
SHARE STRUCTURE
written and oral advertising, disclosures, or agreements (see NCUA

Rules and Regulations 5707.8.)
and - Review Considerations
References - Share Analysis
- Share Greater Than $100,000
- Shares Less Than $0
- Shares Detail
- Share Internal Controls
0 References
107(6) Receipt of Funds
117 Dividends
207(k)(2) Insured Account

Article I11 Shares of Members
Article XII, Section 1, Loans to Members (Organizations)
Article XIV, Dividends
Article XVIII, Section 2(b), Organizations of Such Persons

70 1.19 Retirement Benefits for Employees of Federal
Credit Unions
701.32 Payment on Shares by Public Units and
Nonmembers
701.34 Designation of Low-Income Status; Receipt of
Secondary Capital Accounts by Low-Income
Designated Credit Unions
701.35 Share, Share Draft and Share Certificate
Accounts
701.37(a)(1) Treasury Tax and Loan Accounts
70 1.37(a)(2) Government Depositories and Agents
707.8 Advertising
724 Trustees and Custodians of Pension Plans
748 Suspicious Activity Report
Page 14-7
/ + d W
TYPES OF SHARE ACCOUNTS - APPENDIX 14A
Neither the FCU Act nor the NCUA Rules and Regulations restrict a
federal credit union in the types of member share accounts it can offer.
Generally, share types fall into the broad categories of regular shares,
share drafts, share certificates, money market shares, and retirement
plan accounts. Other less commonly used accounts include escrow,
nonmember, and public unit accounts.
Regular Every federal credit union offers a share account that does not require a
Shares minimum balance greater than the par value of a share, which provides
for continued membership in the credit union. However, federal credit
unions can offer variations of the regular share account (e.g.,
Christmas Club accounts, vacation accounts, no-dividend accounts.)
Share Drafts By traditional definition, a share draft account is an account from

which the authorized holder can withdraw shares by means of a
negotiable or transferable instrument or other order. Share draft
accounts may differ from regular share accounts. Before establishing a
share draft program, the board should determine the economic and
operational feasibility of the members' use of share drafts. Written
operational and program specifications, available at the credit union's
principal office, should support the program.
Settlement In order to make settlement for drafts that a payable-through bank

Accounts provisionally pays, credit unions normally maintain a deposit account
in the payable-through bank. Other alternatives for settlement include
use of an investment account, such as an account with a common trust,
a savings and loan association, or a corporate credit union, through
which funds are transferred to the payable-through bank using
preauthorized agreements. The payable-through bank writes drafts
against these accounts. The bank may also accept drafts in an account
receivable clearing status and at the end of each day draw a draft
against the credit union's checking account in a bank where the credit
union does business.
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EXAMINER'S GUIDE
Internal The FCU Bylaws require that federal credit unions deposit all funds
Accounts except petty cash or change funds; therefore, credit unions may not
establish their own in-house accounts on which they draw drafts.
However, a federal credit union may draw drafts upon itself. Although
a federal credit union may not issue cashier's checks, it may issue
"treasurerk drafts" to make credit union payments. These drafts equate
to a cashier's check, which is a draft drawn by a bank against its assets.
The bank acts as both the drawer and the drawee of the instrument. It
becomes the bank's primary obligation, and constitutes its written
promise to pay on demand. Therefore, while a federal credit union may
draw drafts upon itself, assuming proper accounting procedures and an
awareness of any liability it may incur by doing so, it may not have its
own internal share draft account.
Share A share certificate account earns a dividend at a specified rate (either

Certificates fixed or variable) if held to maturity. Credit unions may assess a
penalty for the early withdrawal of all or any portion of the principal
amount before maturity. Share certificates usually require a minimum
balance. Credit unions design this account to attract and retain larger
share deposits. Generally, accounts having greater restrictions also
have higher dividend rates.
Money Market A money market account, a short-term insured draft account, pays
Accounts competitive money market rates. The credit union determines terms
and conditions according to competition and its own resources.
General characteristics of a credit union money market account

include:
0 Competitive yields (money market rates);

0 Short-term or no maturities;
0 Frequent dividend compounding (e.g., daily);
0 Minimum balances and deposit and withdrawal requirements as
determined by the credit union;
0 Draft access; and
0 Penalties, as determined by the credit union, if the account falls
below the minimum balance requirements.
Page 14A-2
Due to the nature of money market accounts (i.e., short-term, rate-

sensitive), a credit union offering them should have in place an
effective asset-liability management program. To ensure adequate
liquidity, credit unions should have in place a program that relates
these accounts with assets of similar characteristics. (See the Asset-
Liability Management and Liquidity chapters for further information.)
Individual Part 724 of the NCUA Rules and Regulations authorizes a federal
Retirement credit union to act as trustee or custodian of individual retirement
Accounts accounts (IRAs) for its members or organizations of its members. IRAs
act as trusts or custodial accounts, which requires (1) a written
instrument creating the trust, and (2) investment of the funds in share
accounts or share certificate accounts of the federal credit union. The
credit union chooses the design of IRA share and share certificate
accounts, without any maturity or dividend restrictions. The National
Credit Union Share Insurance Fund (NCUSIF) insures these accounts
separately up to a maximum of $100,000.
Credit Union A federal credit union can provide retirement benefits for its
Employees' employees and compensated officers. Except for IRA and Keogh
Retirement accounts, credit unions have no authority to act as a trustee over any
Plans trust accounts. Therefore, for employees and compensated officers, a
federal credit union can only offer the following types of pension
plans:
0 As the sponsor of an employee pension benefit plan with a named

trustee other than the credit union; and
0 As the trustee or custodian for IRAs for employees and
compensated officials of the credit union.
401 K Plan Part 724 of the NCUA Rules and Regulations provides for
development of pension plans that qualify under 401(d) or 408 of
Internal Revenue Code. As a result, credit unions have begun to offer
services in the deferred compensation field. Most major corporations
offer 40 I K Plans, known as "pay conversion plans," deferred pay
plans, or salary reduction plans to their employees. In some credit
unions, the growth in this program is offset by a reduction of payroll
Page 14A-3
EXAMINER'S GUIDE
deduction deposits in credit unions. Advantages of 40 1K plans over

IRAs include a greater per year maximum and the improved
availability of the funds. These accounts reduce current tax obligations
by reducing gross wages.
0rganiza- Only organizations composed exclusively of persons who are within

tional the field of membership may open organizational share accounts. The
Accounts examiner normally determines eligibility on the basis of information
obtained from the organization. If questions arise whether the
organization meets the Bylaw definition, the credit union could apply
for a charter amendment to specifically add the group to its field of
membership.
Escrow Credit unions normally establish an escrow account as a limited access

Accounts share account in conjunction with real estate loans. "Escrow account"
means either a special limited withdrawal share account or an accounts
payable account for the accumulation of funds to pay for taxes,
assessments, insurance premiums, construction proceeds, or other
charges that could affect the credit union's first lien position.
Nonmember Nonmember accounts consist of shareholdings of other federally

Accou nts insured credit unions and, in a credit union designated "low income"
(i.e., serving predominantly low-income members), the shareholdings
of nonmember individuals or organizations (see $701.32 and $701.34
of the NCUA Rules and Regulations.)
Public Unit A credit union may receive payments on shares from member or
Accounts nonmember units of federal, state, and local governments. Because
public unit accounts usually consist of large amounts of funds subject
to immediate redemption, examiners must carefully analyze them. The
term "public unit" means the United States, the District of Columbia,
any state of the United States, the Commonwealth of Puerto Rico, any
territory or possession of the United States, any county, municipality,
or political subdivision thereof. The term "political subdivision"
includes any subdivision or principal department of a public unit if
state statute:
Page 14A-4
Expressly authorized the creation of the political subdivision;

Delegates to the political subdivision some functions of
government; and
0 Allocates funds by statute or ordinance for the exclusive use or
control of the political subdivision.
Treasury Tax Subject to the U.S. Treasury regulations, a federal credit union may:
and Loan
Accounts 0 Serve as a Treasury Tax and Loan (TT&L) depositary; a depositary
of federal taxes, a depositary of public money, and a financial
agent of the U.S. Government;
0 Deem funds held in a TT&L Remittance Account, a TT&L Note
Account, a Treasury General Account, and a U.S. Treasury Time
Deposit-Open Account ($701.37) as deposits of public funds; and
0 Exempt funds held in such accounts from the 60-day notice
requirement of Article 111, Section 5(a) of the FCU Bylaws.
A credit union can hold funds in a TT&L Remittance Account

established for receipt of payments of federal taxes and certain U.S.
obligations. The Federal Reserve Bank (FRB) may withdraw the funds
immediately upon receipt of supporting advices. Funds held in a TT&L
Remittance Account and a TT&L Note Account are added together and
insured to a maximum of $100,000.
A TT&L depositary may credit funds to its note representing payments

for U.S. Savings Bonds issued by the credit union in its issuing agent
capacity and payments for U.S. Savings Bonds subscribed for through
the TT&L accounts, and may enter into such custodial arrangements as
necessary to meet Department of Treasury requirements for collateral
on a TT&L depositary. The examiner should determine that copies
exist of the application and board of directors' resolution authorizing
the credit union to be a TT&L depositary regarding compensation
owed and payments due the Treasury. The statement will include:
0 The number of federal tax deposit forms, which comprise the basis
for the compensation;
The fee factor;
0 The total compensation due; and
0 Interest on late fees due the Treasury.
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EXAMINER’S GUIDE
The district FRE3 or Financial Management Service of the U.S.

Treasury can answer specific questions about TT&L accounts.
Depository A federal credit union may act as a depository or financial agent of the
and us Agent U.S. Government under the provisions of Title 3 1, C.F.R. 202 of the
Account Department of Treasury Regulations, which permits federal credit
unions acting under this authority to:
0 Maintain accounts as specified by the U.S. Treasury in which

balances may exceed the insurance coverage provided for in
§207(k)(2) of the FCUAct.
Maintain accounts in the name of the U.S. Treasury. Such accounts

may include:
- A Treasury General Account, which may carry a zero balance

and from which the depositor may immediately withdraw the
entire balance, under all circumstances except the credit
union’s closure;
- A U.S. Treasury Time Deposit-Open Account, which is non-

dividend bearing and which generally, may not be withdrawn
until the expiration of 14-days after the date of the U.S.
Treasury’s written notice;
0 Accept deposits to these accounts for the credit of the U.S.

Treasury;
0 Furnish drafts in exchange for collections in these accounts; and
Pledge specifically identified assets as collateral to secure public

funds under provisions specified in 3 1 C.F.R. 202.6.
Public unit accounts include funds in a Treasury General Account and

the U.S. Treasury Time Deposit-Open Account. As such, funds in a
Treasury General Account and a U.S. Treasury Time Deposit-Open
Account are added together and insured up to a maximum of $100,000
in the aggregate.
Page 14A-6
Funds held in a U.S. Treasury Time Deposit-Open Account do not

constitute borrowings for purposes of 5 107(9) of the FCU Act, and are
not subject to the 60-day notice requirement of Article 111, Section 5(a)
of the FCU Bylaws.
Business Examiners need to consider the following when reviewing business

Share share accounts:
Accounts
0 Rules and RegulationsBylaws;
Advantages/Disadvantages;
Type of Account
0 Internal Controls; and
0 Recommended Examination Procedures (if applicable.)
When the membership needs business share accounts and the credit
union has the ability to effectively offer them, this service can provide
several advantages, including:
Retaining the business of sponsor organizations, small

entrepreneurs, and that segment of the membership requiring
business accounts; and
Providing the credit union with growth potential beyond

individual-member accounts. Offering business share accounts
could increase credit unions’ shares and improve net earnings
(depending on cash flows and fee structures).
Disadvantages can also exist, including:
0 Large balance accounts in relation to the asset size of the credit

union may result in undue influence on the officials and
management. Most vulnerable are small credit unions. Examiners
may need to focus loan reviews towards large business-account
members and related members’ accounts for the possibility of
preferential treatment;
0 Low average daily balances and a large number of transactions can

render business accounts unprofitable. If credit unions cannot
Page 14A-7
EXAMINER’S GUIDE
restructure these accounts to at least a point of break-even, other

services must subsidize this service; and
0 Large business accounts can distort the credit union’s trend

analysis. Examiners should recognize the effect of major balance
shifts in assessing the total analysis process.
Other possible disadvantages include:
Excessive involvement by sponsor organizations in the credit

union’s operations;
0 Need for comprehensive cash flow analysis;
Cost of special access to services (ie., coin processing, check
cashing, etc.); and
0 Inadequate controls regarding compensating balances.
In general, businesses may request business savings and share-draft

accounts (e.g., sole proprietorships, small corporations, and small
partnerships.) Credit unions offering business share accounts must
implement adequate controls to ensure large business accounts, in
either volume or dollar amount, do not pose a safety and soundness
concern. Credit unions do this by requiring written policies and
procedures, and establishing adequate internal controls and oversight.
Policies and procedures must specify the various business-related share

accounts and the credit union’s objective in offering these accounts.
Examiners should encourage management to establish objectives that
include quantifiable financial goals consistent with the credit union’s
capital goals and long-term business plan.
The policy must ensure employees adequately document membership

eligibility. Credit unions should identify and monitor business
accounts separately from other share accounts. Internal controls should
include data processing controls for pledged shares or compensating
balances, if applicable.
Page 14A-8
SHARE ACCOUNT RED FLAGS - APPENDIX 14B
Red Flags Examiners should remain aware of the following red flags (not an all-
inclusive list) when reviewing share accounts.
Failure to set restrictions on employees processing transactions on

their own accounts, the accounts of their family members, and
those of their relatives;
Failure to set computer access controls on authority levels to post
transactions;
Failure to require passwords or a teller ID number for each staff
person to identify accountability;
Employees’ failure to produce records or to delay access to
records;
Long-standing problem of records not posted currently or being
out-of-balance;
Employee salaries and fringe benefits substantially below those of
other credit unions providing equivalent services. Employees may
reason the board is shortchanging them and may attempt forgery to
overcome their perception of being under-compensated;
Employees who live beyond their standard of living on their visible
income, often indicated by luxury cars, expensive hobbies,
gambling, or heavy drinking;
Employees who resist taking vacations or resist attempts for
someone else to perform their work during vacation;
Employees who resist giving up control of certain records to
another employee when promoted to a new position (e.g.,
performing the bank reconcilement);
Failure to review negative Share and Share Draft Reports;
Failure to review Dormant Share Reports;
Cost of funds exceeds dividend rates;
Credit union share growth not commensurate with above market
dividend rates paid;
Print command coded to suppress printing of statement of
accounts;
Numerous statement of accounts delivered to the same P.O. Box;
Member complaints on accuracy of their statement of accounts;
Failure to mail statement of accounts;
Page 14B-1
EXAMINER’S GUIDE
0 Share trial balance report header shows not all share accounts were
selected for printing on the share trial balance;
0 Missing or incomplete membership cards; or
0 Failure to correct internal control weaknesses identified in
examinations, supervisory committee audits, internal audits, and
risk-management analysis audits.
Examiners should use their professional judgment in questioning high-

risk practices involving share accounts.
Page 14B-2
Chapter 15
PROFITABILlTY
TABLE OF CONTENTS
PROFITABILITY ............................................................................................................ 15-1

Statement of Income ............................................................................................ 15-2
Pro-Forma Estimations ........................................................................................ 15-2
Analysis of Profitability ....................................................................................... 15-3
Gross Income to Average Assets .......................................................................... 5-4
Yield on Loans ..................................................................................................... 15-4
Operating Expenses to Average Assets ............................................................... 15-4
Net Operating Expenses to Average Assets ......................................................... 15-5
Cost of Funds to Average Assets .......................................................................... 5-5
Net Interest Margin to Average Assets ................................................................ 15-5
Return on Average Assets .................................................................................... 15-5
Workpapers .......................................................................................................... 15-6
Chapter 15
PROFITABILITY
Examination 0 Review income and expense trends
Objectives 0 Analyze budget projections and practices
0 Evaluate due diligence by management of services and products
affecting the credit union’s profitability (e.g., cost-benefit
analysis)
Determine adequacy of policies and practices addressing income
and expenses
Compare actual performance to the income and expense budget
and capitalization goals
Determine sufficiency of earnings to cover operating expenses,
dividends, and necessary reserve transfers
Determine adequacy of earnings to increase the net worth ratio (if
necessary) or to maintain the net worth ratio at or above
established benchmarks
0 Ensure compliance with applicable laws, regulations, accounting
practices, and policy statements when recording income and
expense items
a Determine that management has instituted prompt correction of
deficiencies or exceptions
Associated 0 Credit risk can result from poor underwriting of loans or high-
Risks risk investments;
0 Interest rate risk can result from insufficient net interest margin
to cover operating expenses;
0 Liquidity risk can result from inadequate pricing policies, and
failure to properly structure share and loan products resulting in
weak or negative profitability;
0 Strategic risk can result from failure of management to plan for
sufficient resources to fulfill business plans or continue offering
competitive products and services; and
0 Reputation risk can result from loss of member confidence and
withdrawal of member shares due to questions regarding the
credit union’s on-going viability.
Page 15-1
EXAMINER'S GUIDE
Statement Of The Statement of Income displays basic information about a credit

Income union's profitability. This workpaper compares profitability from the
prior yearend to the current period. The examiner can tailor the
workpaper to calculate the individual line items as a percentage of
either total assets, average assets, total income, or total expenses.
The Financial History and Key Ratios workpapers display
profitability trends for prior periods.
If the credit union has a profitability problem, the examiner will

evaluate the cause of the deficiency. Examiners may prepare
additional schedules or custom worksheets to analyze specific items
(e.g., fee income, miscellaneous income, cash over and short, travel
and conference expense, operating expenses, professional and outside
services, miscellaneous expense, or any non-operating expense).
Pro-Forma Examiners may find it necessary to estimate material items such as

Estimations dividends, reserve transfers, operating income, and operating
expenses (if they are not accrued) during an examination or
supervision contact performed as of a date other than the end of an
accounting period. The estimates can reveal whether the credit union
has sufficient earnings to declare its anticipated dividend. It will also
show the net effect the dividend will have on net worth. Calculation
of estimated dividends may require averaging the prior two periods'
dividend-to-shares ratio (taking into account any expected changes in
dividend rates) and multiplying the ratio by the average shares
outstanding since the prior dividend period.
Example: Assume a September 30 examination in a credit union that offers

only regular shares and pays dividends semiannually. As of June 30, the
average share balance for the quarter was $350,000 and dividends totaled
$3,938. The dividend-to-shares ratio is $3,938/$350,000 = .01125.
On December 3 1 of the prior year, the average share balance for the 6-month
period was $400,000 and the dividend cost was $4,700. The dividend-to-shares
ratio is $4,700/$400,000 = .01175. The average of the prior two periods'
+
dividend-to-shares ratio is 1.15 percent (( 1.125 percent 1.175 percent)/2).
Assume July 31 shares totaled $475,000, August 31 shares totaled $500,000,

and September 30 shares totaled $525,000. Average shares is ($475,000 +
+
$500,000 $525,000)/3 = $500,000.Multiplying the average shares by the
dividend-to-shares ratio yields $500,000 x 1.15 percent = $5,750, which is the
current period's estimated dividend. As of the examination date, the credit
union has recorded only one-half or $2,875 as the estimated dividend. The
effective annual cost of shares is the result of multiplying the dividend-to-
Page 15-2
EXAMINER'S GUIDE
indicate the additional profit necessary to increase the net worth ratio
to a specified level over a selected number of years.
Examiners can also use the Two Minute Profitability Test for
reviewing the credit union's budget relative to its net worth goals.
Gross hmm? The gross income to average assets ratio reflects the rate at which the
to Average assets produce income. Since assets include such non-earning items
Assets as prepaid expenses and furniture and equipment, this ratio usually is
less than the credit union's interest rate on loans. If the credit union
has a low gross income to average assets ratio, or a negative or
declining trend, the examiner may extend the analysis to determine
the cause of the decreased income. Individually analyzing the yield
on loans, yield on investments, and other major assets can assist the
examiner in this determination. If these ratios do not point out the
cause of the adverse trend, the examiner may look for a major fixed-
asset purchase or some other increase in non-earning assets (e.g., the
volume of delinquent loans greater than 90 days.)
Yield on The yield on loans is the rate at which loans produce income. This
Loans ratio usually is less than the interest rate charged for loans because it
does not consider unaccrued interest on delinquent loans. Examiners
should determine the reasonableness of the yield on loans for the
types of loans in the credit union's portfolio. The yield on loans
should not deviate substantially from the weighted average interest
rate charged on loans. If the yield on loans reflects a negative trend,
the reasons may include an increase in delinquency, decreased
collections, or a reduction in interest rates.
Operating Operating expenses to average assets reflects the percentage of assets

Expenses to used for operations. If this ratio is high or if there is an increasing
Average trend, examiners should determine the cause.
Assets
Page 15-4
PROFITABILITY
Net Net operating expenses to average assets considers net operating cost
Operating when evaluating operating expenses. Fee income reduces total
Expenses to operating expenses. This ratio tends to put the overall expense
Average picture into focus for those credit unions that offer expensive
Assets services but recoup some or all of the costs by assessing fees.
Comparison of this ratio with the operating expenses to average

assets ratio provides additional information about the degree to which
the credit union depends on fee income.
cost of Cost of funds to average assets reflects the percentage of assets used
Funds to for dividends and interest on borrowed money. Examiners should
Average determine the cause of a high ratio or increasing trend. Calculating
Assets the cost of various share types and the cost of borrowed money ratios
can assist in this determination. The mix of deposits between lower-
costing regular shares and higher-costing share certificates directly
affects the cost of shares. By reviewing growth trends by share
category, examiners can better isolate changes.
Net Interest The net interest margin to average assets ratio measures whether
Margin to income from loans and investments sufficiently covers the cost of
Average funds. In general terms, if the credit union properly matches assets
Assets and liabilities, this ratio should remain constant in varying interest
rate cycles. A fluctuating ratio could indicate a change in loan rates
charged, a change in investment practices, or (in a rapidly changing
rate environment) a slow adjustment of dividend rates paid.
Examiners may determine the cause of a low or fluctuating ratio.
Return on The return on average assets ratio is the percentage of assets that the
Average credit union realizes as profit before reserve transfers. A negative
Assets trend usually indicates a problem that requires addressing with the
officials or, if material, in the examination report. A negative ratio
may require the examiner to determine the cause and help officials
develop corrective actions The urgency of the situation depends on
the degree of negativity in the trend and the amount of available
reserves. Available revocable reserves and earnings determine how
Page 15-5
EXAMINER'S GUIDE
long the credit union can support negative earnings without affecting
dividends or operations.
Example: If a $2 million credit union has $22,000 in Undivided Earnings and

a Net Loss From Operations ratio of -0.6 percent, the credit union will lose
0.6 percent times $2,000,000 per year, or $12,000 under present conditions.
Therefore, the credit union has 22 months or less to improve operations.

However, if the -0.6 percent were the 12-month ratio, and the latest three-
month ratio is -0.9 percent, the trend indicates an accelerating loss rate and
dramatically reduces the period in which corrections must take place.
To determine the longest time available, examiners should first calculate the
annual loss and then convert it into months:
$2,000,000 x -0.9 percent = $18,000 / 12 months = $1,500 loss per month.
At that rate, the credit union will deplete its $22,000 in Undivided Earnings in
a maximum 15 months.
The accelerating loss rate may reduce the maximum period. Unless
management makes changes, the credit union has less than 15 months in which
to operate. A review of the ratio should reveal the validity of this assumption,
or determine if less time actually remains to correct the problem.
Once identified, examiners should work with the credit union to

correct the problems causing the negative trend. Examiner-designed
workpapers may assist in determining and documenting the causes of
the negative trends and lead toward corrective action in the
Document of Resolution. When necessary, the examiner may choose
to use the Supplementary Facts or any examiner-designed workpaper
to highlight and explain the key ratios to the officials to increase
their understanding
- Financial History
- Key Ratio
- Statement of Income
- Two Minute Profitability Test
Page 15-6
Chapter 16
NET WORTH AND OTHER EQUITY ACCOUNTS
TABLE OF CONTENTS
NET WORTH AND OTHER EQUITY ACCOUNTS .................................................... 16. 1

Overview ............................................................................................................. .16.2
Secondary Capital for Community Development Credit Unions ....................... 16-4
GAAP vs . RAP .................................................................................................... 16-6
Other Considerations ........................................................................................... 16-7
Capital and Solvency Evaluation ............................................................. 16.7
Undivided Earnings ............................................................................................. 16-8
Regular Reserve .................................................................................................... 6-9
Accumulated Unrealized GainsLosses on Available for Sale Securities............16-9
Chapter 16

Examination 0 Determine whether the credit union complies with Regulation D,
Objectives if applicable
0 Ascertain compliance with the Credit Union Membership Access
Act (CUMAA)
0 Determine whether the credit union has sufficient net worth for
its degree of risk
0 Determine whether the credit union has adequate policies,
practices, and procedures regarding net worth and capital
accounts
0 Determine if officials and employees adhere to established
policies, practices, and procedures regarding net worth and
capital accounts
0 Determine whether reserve accounts are audited periodically
0 Determine whether reserve accounts comply with the CUMAA,
FCU Act, NCUA Rules and Regulations, and appropriate
accounting guidance
Determine if the credit union promptly corrects deficiencies or
violations noted during examinations or audits
Associated Credit risk can result from poor underwriting of loans or high-
Risks risk investments;
Interest rate risk can result from insufficient net interest margin
to cover operating expenses;
0 Liquidity risk can result from inadequate pricing policies, and
failure to properly structure share and loan products resulting in
weak or negative profitability;
Strategic risk can result from failure of management to plan for
sufficient resources to fulfill business plans or continue offering
competitive products and services;
0 Transaction risk can result from failure to establish and
implement policies and procedures that ensure the accuracy and
integrity of data and information;
0 Compliance can result when credit unions fail to comply with
Page 16-1
EXAMINER’S GUIDE
Reputation risk can result from loss of member confidence and

withdrawal of member shares due to questions regarding the
credit union’s on-going viability.
Overview The adequacy of the credit union’s reserves should correlate to the
amount of risk it has taken or plans to take.
Two types of reserves apply to credit unions: cash reserves and

equity reserves. Cash reserves include transaction account reserves
required by Regulation D. Credit unions hold cash reserves in the
following forms:
Vault cash;
A balance maintained directly with the Federal Reserve Bank
(FRB) in the District in which the credit union is located; or
A pass-through account, which is considered a balance
maintained with the FRB.
Cash reserves usually do not apply to smaller credit unions;

however, equity reserves apply to all credit unions. Credit unions
establish equity reserves (also called capital) by segregating part of
their net income into reserve and undivided earnings accounts.
Equity reserves may be either appropriated or unappropriated.
A credit union’s capital is defined as the total of its regular reserves,

allowance for loan and lease losses, special reserves, undivided
earnings, accumulated unrealized gains or losses on available-for-sale
(AFS) securities, and that portion of year-to-date net income that has
not yet been closed to the appropriate capital account. Capital
accounts provide (1) a cushion for anticipated and unidentified
losses, (2) a base for future growth, and (3) a means by which the
credit union can meet competitive pressures as they arise. Capital
provides the credit union a cost-free source of funds.
Net worth is defined as the retained earnings balance of the credit

union at quarter end as determined under generally accepted
accounting principles (GAAP). See the FCU Act §216(d)(o)(2).
Retained earnings consist of undivided earnings, regular reserves,
and any other appropriations designated by management or
Page 16-2
regulatory authorities. Net worth does not include the Allowance for
Loan and Lease Losses account. This means that net worth only
includes undivided earnings and appropriations of undivided
earnings. (Refer to the Prompt Corrective Action chapter of this
Guide for additional information.)
A strong net worth position enables a credit union to take on more

risk than can a credit union with a weak net worth position. A
stronger overall net worth position better enables a credit union to
deal with future uncertainties such as asset losses, sponsor layoffs,
and adverse economic cycles.
The credit union board should have a plan for defining and
maintaining an adequate net worth level. The examiner should
review the net worth position and the officials' philosophy toward
building and maintaining net worth. If the net worth position does
not meet the credit union's short- or long-term needs, the examiner
should determine if the shortfall poses a threat to safety and
soundness.
Examiners may find the following ratios useful in reviewing capital

and net worth:
Net Worth to Assets;

Net Worth Growth vs. Asset Growth (trend);
Capital to Assets;
Net Capital to Assets;
Capital Growth to Asset Growth;
Net Worth to Loans;
Classified Assets to Net Worth;
Total Delinquent Loans to Net Worth; and
Solvency Evaluation.
When analyzing the adequacy of reserves and net worth, examiners

should consider the following factors:
8 Size of the credit union;

8 Complexity of products and services;
Degree of sponsor support;
Level of management's expertise;
Page 16-3
EXAMINER’S GUIDE
0 Quality of management’s due diligence for existing and new

products, services and systems;
Involvement of the officials;
0 Interest rate risk;
0 Internal control structure;
0 Stability and diversity of the field of membership; and
0 Concentrations of credit and savings.
Examiners should also consider the amount of coverage provided by

the credit union’s surety bond. §713.5(a) of the NCUA Rules and
Regulations defines the minimum coverage required. Some of the
newer bond forms provide significantly less coverage than the
standard bond. Examiners should ensure the credit union maintains
adequate bond coverage. See the Bond Coverage chapter of this
Guide for additional guidance.
Secondary Federally insured credit unions designated as low-income may

Capital for establish secondary capital accounts, which examiners should review
Community for compliance with §701.34(b) of the NCUA Rules and Regulations.
Development Before offering secondary capital accounts, the credit union must
Credit Unions adopt, and forward to the appropriate regional director, a written
plan for use of the secondary capital account funds and subsequent
liquidity needs to meet repayment requirements upon maturity of the
accounts.
The following restrictions apply to these secondary capital accounts:
0 Establishment as an uninsured secondary capital account or other

form of non-share account;
0 Minimum five years maturity;
0 Not redeemable before maturity;
Not insured by the National Credit Union Share Insurance Fund

(NCUSIF) or any governmental or private entity;
Page 16-4
0 Holder’s claim against the credit union is subordinate to all other

claims, including those of shareholders, creditors, and the
NCUSIF;
Required availability of funds deposited, including interest

accrued and paid into the secondary capital account, to cover
credit union’s operating losses that exceed net available reserves
and undivided earnings (i.e., exclusive of allowance accounts for
loan and lease losses.) Credit unions may not replenish the
account for funds so used. Credit unions may pay interest
accrued on the secondary capital account directly to the investor
or into a separate account available to the investor for
-
withdrawals. Pro-rata distribution of realized losses among all
secondary capital accounts held by the credit union is required;
0 May not pledge as security on a loan or other obligation with the

credit union or any other party;
Account funds not needed for covering losses at the time of

merger (other than merger into another low-income designated
credit union) or voluntary dissolution will be closed and paid out
to the account holder;
Contract containing terms and conditions required between

representative of the account holder and the credit union; and
Disclosure and acknowledgment signed by representative of

account holder is required and the account holder will receive
copies of contract and disclosure at the time of entering into the
account agreement (see the Appendix to 5701.34 of the NCUA
Rules and Regulations.) Credit unions must retain original copies
of the contract and the disclosure and acknowledgment for the
term of the agreement.
The regulation establishes a declining scale for the capital value of

accounts with less than five years remaining maturity. Even so, all
funds will continue to be at risk to cover losses that exceed reserves
and undivided earnings. The declining scale addresses accounts with
remaining maturities of at least the following:
Page 16-5
EXAMINER’S GUIDE
Four years, but less than five years - counted as capital at 80

percent of face value;
Three years, but less than four years - counted as capital at 60
Two years, but less than three years - counted as capital at 40
One year, but less than two years - counted as capital at 20
percent of face value; and
Less than one year remaining maturity - counted as capital at 0
percent of face value.
Examiners should review the disclosure and acknowledgment that the

account holder’s authorized representative must provide and execute.
(See disclosure in the Appendix to 5701.34 of the NCUA Rules and
Regulations. )
GAAP vs. GAAP classifies secondary capital accounts as subordinated debt. As

RAP such, the account holder does not have voting or ownership rights.
However, NCUA adopted a regulatory accounting position (RAP)
that recognizes secondary capital accounts for low-income designated
credit unions as capital accounts. This RAP position applies to all
credit unions having a low-income designation, including those with
assets equal to or greater than ten million. Examiners should
understand that the credit union’s outside auditor may recognize
these accounts as subordinated debt, and reflect the entire balance in
these accounts in the liability section of the balance sheet consistent
with GAAP for financial statement presentation.
Examiners should record secondary capital as “Other Revocable

Reserves’’ in the equity section of the balance sheet to ensure their
inclusion in capital when AIRES calculates CAMEL component and
composite ratings. For secondary capital accounts having a
remaining maturity of less than 5 years, AIRES requires examiners
to split them into capital (Other Revocable Reserves) and non-capital
(Other Liabilities) components based on the sliding scale (see the
NCUA Rules and Regulations §701.34(c)).
The credit union records secondary capital accounts that have capital
value (based on the sliding scale) as “Secondary Capital -
Page 16-6
Uninsured”. Credit unions must transfer the portion of secondary

capital accounts not considered capital to “Subordinated CDCU
Debt” (The Accounting Manual for Federal Credit Unions contains
more information on this subject.)
When reviewing call reports of low-income designated credit unions

that have secondary capital accounts, examiners should ensure proper
recording of these accounts. Credit unions should not use the
Uninsured Secondary Capital line on the call report for reporting any
other type of capital.
Other A low-income credit union must include secondary capital accounts

Consider- in its total borrowing amount. The FCU Act §107(9) limits credit
ations union borrowing to 50 percent of paid-in and unimpaired capital and
surplus.
Part 705 of the NCUA Rules and Regulations addresses the

Community Development Revolving Loan Program for Credit
Unions (the Program). A participating credit union may receive up to
$300,000 in the form of a loan, which the credit union must match
by increasing its shares by a like amount (see the Low-Income Credit
Union chapter of this Guide for more information about the
Program). The regulation’s matching requirement encourages credit
unions to develop a permanent source of member shares as rapidly as
possible.
Since secondary capital accounts are not member share accounts,

low-income designated credit unions may not use secondary capital
accounts as matching funds for purposes of the Program.
Additionally, the limitations on public unit and nonmember accounts
described in §701.32(b) do not apply to secondary capital accounts.
Capital and When reviewing reserve accounts, the examiner should consider
Solvency capital adequacy, net worth, trends, materiality, unusual activity,
EvaIuation and thoroughness of the audit work. In addition, the level of capital
in relation to the perceived level of risk will determine the degree of
review.
Page 16-7
EXAMINER'S GUIDE
Undivided The examiner should determine that the credit union appropriately
Earnings accounts for its undivided earnings account. It should pay particular
attention to the positive and negative growth trends of this account.
A decreasing trend may trigger a detailed review to determine the
cause.
When analyzing the adequacy of the undivided earnings account, the

examiner should consider the following:
Current and anticipated earnings capacity of the credit union;

Quality of the loan and investment portfolios (overall
assessment); and
0 Unanticipated events, such as adverse economic conditions
causing plant closings, layoffs, etc.
Credit unions cannot pay dividends, without the prior approval of the
regional director if the payment results in a deficit in the undivided
earnings account. Credit unions experiencing a deficit, or those in
which paying a dividend would result in a deficit, must request and
receive approval for 208 Assistance before paying dividends.
If a credit union has a deficit balance in the undivided earnings

account at the time of the examination, the examiner should
determine if it paid a dividend during the last accounting period. If it
did pay a dividend, the dividend was material, and the examiner
believes there was obvious intent on the part of the officials to pay an
illegal dividend, then the examiner should consider initiating an
administrative action against the responsible parties. The examiner
should not recommend that the officials recall the dividend because
neither the officials nor the NCUA Board has that authority. If the
shareholders received the illegal dividend in good faith and without
knowledge of the credit union's financial condition, they have no
legal obligation to refund the dividend.
However, the examiner should reach an agreement with the officials

that a dividend declared at the end of the next accounting period will
not exceed available earnings after elimination of the deficit.
Examiners should treat an illegal dividend as an area of concern.
Page 16-8
Regular The regular reserve is a statutory reserve account. When analyzing

Reserve the adequacy of this account’s balance, the examiner should consider
the credit union’s compliance with statutory reserving requirements,
including net worth restoration plans. Refer to 5702.201 of the
NCUA Rules and Regulations for guidance on transfers into this
account.
Accumulated This account records unrealized gains and losses on available for sale
UnreaIized securities. When credit unions write available for sale securities to
Gains/Losses fair value, they make an entry directly to the investment account with
on Available the corresponding debit or credit to the accumulated unrealized gain
for Sale and losses on the available for sale securities account. The credit
Securities union nets this account against undivided earnings when assessing a
credit union’s ability to pay dividends.
and - Regular Reserves
References - Undivided Earnings
- Accumulated Unrealized GaidLoss on Investments
- Special Reserves
- Other Reserves
- Contingency
- Appropriated Undivided Earnings
- Critical Solvency
References
107(9) - Borrowing Limitation
216 - Prompt Corrective Action
701.32 - Payment on Shares by Public Units
and Nonmembers
701.34 (Appendix) - Disclosures and
Acknowledgment
702 - Prompt Corrective Action
702.2(f) - Definition of Net Worth
702.34(b) - Receipt of Secondary Capital Accounts by
Low-Income Designated Credit Unions
702.401 - Reserves
Page 16-9
EXAMINER'S GUIDE
705.7 - Loans to Participating Credit Unions

713 - Fidelity Bond and Insurance Coverage for
Federal Credit Unions
- NCUA Letter to Credit Unions #182, dated November 1995
- NCUA Instruction No. 4020
- NCUA Accounting Bulletin 95-1
Page 16-10
Chapter 17
PROMPT CORRECTIVE ACTION
TABLE OF CONTENTS
PROMPT CORRECTIVE ACTION PART 1 ................................................................ .17/1. 1

Associated Risks ................................................................................................. .17/1. 1
Overview............................................................................................................. .17/1. 1
. . ...........................................................................................................
Definitions .17/1.2
Net Worth Calculation ......................................................................................... 17/1-5
Statutory Net Worth Categories ........................................................................... 17/1-8
Net Worth Category Change................................................................................ 17/1-8
Reclassification ....................................................................................... .17/1.9
Mandatory Supervisory Actions ......................................................................... .17/1.9
Discretionary Supervisory Actions ..................................................................... .17/1. 12
Appeals Process ................................................................................................... 17/1- 17
Discretionary Conservatorship or Liquidation.................................................... .17/1.17
Mandatory Conservatorship, Liquidation, or Other Corrective Action
(OCA) .................................................................................................................. 17/1-18
OCA Renewal .......................................................................................... 17/1-18
Limitation on OCA Renewals.............................................................................. 17/1-18
OCA Documentation .............................................................................. .17/1.20
Exception to Mandatory Liquidation ....................................................... 17/1-20
Consultation with SSA........................................................................................ .17/ 1.2 1
Net Worth Restoration Plan ................................................................................. 17/1-21
Revised Business Plans ............................................................................ 1711-23
NWRP and Revised Business Plan Approval ......................................... .17/1.25
Examiners' On-Going Review of NWRP ................................................ 17/1-26
Plan Changes............................................................................................. 17/1-26
Assistance In Preparing Plan ................................................................... .17/1.27
Examiner Assistance ............................................................................... .17/1.28
References and Workpapers................................................................................. 17/1-28
PCA .RISK-BASED NET WORTH REQUIREMENT PART 2 ................................... 17/24
. . Objective
Examination . . ........................................................................................ .17/2. 1
Associated Risks ................................................................................................. .17/2. 1
Overview.............................................................................................................. 17/2-1
Standard Calculation ............................................................................................ 17/2-2
Alternative Calculation ........................................................................................ 17/2-4
Risk Mitigation Credit ........................................................................................ 1712-7
References and Workpapers................................................................................ .17/2.8
APPENDIX 17A .Weighted Average Life .................................................................... . 1 A.
71
APPENDIX 17B .Net Worth Restoration Plan (NWRP) Sample Format..................... . 1 B.
71
Chapter 17 - Part I

Examination Assess the calculation for the net worth ratio as mandated by
0bjectives Congress
0 Determine whether the credit union meets the definition of
complex and must adhere to the applicable risk-based net worth
(RBNW) requirement
Determine whether mandatory supervisory actions (MSAs) apply
to the credit union
Determine whether discretionary supervisory actions (DSAs) apply
to the credit union
Assess whether the Net Worth Restoration Plan (NWRP) or, for
new credit unions, the Revised Business Plan, meets the
requirements of the statute and provides sufficient measures for the
credit union to achieve and maintain a minimum six percent net
worth ratio
Determine the criteria for mandatory and discretionary
conservatorships and liquidations
Associated 0 Reputation risk may occur when PCA efforts are not successful
Risks and the credit union fails.
Overview (Please note that at the time of this writing, the NCUA Board was considering
revisions and adjustments to Part 702, Prompt Corrective Action. This chapter does
not reflect any proposed changes. Therefore, users should also consult the latest
version of Part 702 when relying on this chapter as a guide to implementationof
PCA.)
The Credit Union Membership Access Act (CUMAA) amended the

Federal Credit Union Act to mandate a system of net-worth based
capital standards for federally insured credit unions (FICUs.) This
amendment to the FCU Act required the NCUA Board to (1) adopt, by
regulation, a system of PCA to restore the net worth of inadequately
capitalized FICUs; and (2) develop an alternative system of PCA for
new credit unions that carries out the purpose of PCA while allowing
reasonable time to build net worth to an adequate level. PCA does not
limit NCUA’s authority to take additional supervisory action. The
Page 1711-1
EXAMINER’S GUIDE
NCUA Board often delegates specific authority to the regional

directors (FCU Act $21 6, NCUA Rules and Regulations $702.20 1,
§702.202-§702.204, §702.303-§703.305, and $741.3.)
Part 702 of the NCUA Rules and Regulations establishes the

components and requirements of PCA. As a credit union’s net worth
ratio continues to decline, the actions required of the credit union to
restore its net worth ratio to an acceptable level become progressively
more stringent. Subpart B addresses requirements for credit unions that
do not meet the definition of new; while Subpart C addresses
requirements for credit unions defined as new. The three main
components of PCA include:
0 A framework combining:
- MSAs prescribed by Congress and indexed to five statutory net

worth categories, and
- DSAs developed by NCUA to enhance PCA when imposed;
Alternative PCA requirements for credit unions defined by

CUMAA as new; and
RBNW requirement for credit unions that NCUA defines as
complex.
Definitions PCA definitions for some terms may differ from their definitions for
other purposes. The following definitions also apply to new credit
unions unless otherwise specified:
Complex and applicable RBNW requirement. For purposes of $702.102, a

credit union is defined as complex and a RBNW requirement applies only if the
credit union meets both of the following criteria as reflected in its most recent
call report:
- Minimum asset size - its quarter-end total assets exceed $10 million; and
- Minimum RBNW calculation - its risk-based net worth requirement as
calculated under $702.106 exceeds 6 percent.
(Examiners should use the term “applicable RBNW requirement” rather than
“complex.”)
0 Contribution. Per generally accepted accounting principles (GAAP), a

contribution consists of cash or other assets the credit union receives
unconditionally. Under GAAP, credit unions report donations in the form of cash
Page 17/1-2
or other assets (e.g., fixed assets) as contributions and recognize them as

revenues of the period. The credit unions would close them from net income into
undivided earnings. Thus, the credit union will include these amounts in net
worth. However, any condition placed on the donation prohibits the credit union
from accounting for it as a contribution, and conditional donations will not count
as part of net worth.
0 Discretionary supervisory actions (DSAs.) Those actions developed by NCUA

to supplement MSAs, and described in more detail in this chapter ($702
Subparts B and C.) DSAs do not include Discretionary Conservatorship or
Liquidation under §702.203(c) and §702.304(c.)
0 Mandatory supervisory actions (MSAs) for credit unions that do not meet
the definition of new. The following four Congressionallyprescribed MSAs
apply to undercapitalized credit unions with less than 6 percent net worth. The
earnings transfer to regular reserves also applies to adequately capitalized credit
unions with net worth ratios of 6 percent to less than 7 percent. MSAs consist of
the following (5702 Subpart B):
- Earnings transfer to regular reserves;

- NWRP;
- Restriction of asset growth; and
- Restriction of member business loans.
0 Mandatory supervisory actions (MSAs) for credit unions that meet the
definition of new. The following MSAs, developed through NCUA regulation,
apply to new credit unions (5702 Subpart C):
- Earnings transfer to regular reserves;

- Submission of a revised business plan; and
- Restriction of member business loans.
0 NCUA examiner. Any NCUA district examiner, economic development

specialist, problem case officer, or AMAC staff member.
Net worth. The retained earnings balance of the credit union at quarter end as
determined under generally accepted accounting principles (GAAP) (§702.2(f)).
Retained earnings consist of undivided earnings, regular reserves, and any other
appropriations designated by management or regulatory authorities. This means
that only undivided earnings and appropriations of undivided earnings are
included in net worth. For low-income designated credit unions, net worth also
includes secondary capital accounts that are uninsured and subordinate to all
other claims, including claims of creditors, shareholders and the NCUSIF. Net
worth does not include (1) the Allowance for Loan and Lease Losses account;
(2) the Unrealized Gain/Loss on Available for Sale Securities; (3) contributions
of tangible fixed assets recorded as Donated Equity, per regulatory accounting
practice (RAP) that have not been closed into income, or any donations
encumbered by conditions; or (4) alternative sources of capital (e.g., secondary
capital and paid-in-capital accounts) except as noted above. See also the
definition of Retained Earnings.
0 Net worth ratio. The ratio of the net worth of the credit union (numerator) to
the total assets of the credit union (denominator) described in more detail in this
chapter (§702.2(g)).
Page 1711-3
EXAMINER’S GUIDE
Net Worth Restoration Plan (NWRP.)Management’s written plan detailing

the steps the credit union will take to become adequately capitalized by the end
of the plan’s term, and remain so for four consecutive quarters. The credit union
will submit the plan within the mandated time frames to the appropriate regional
director and, if state-chartered, the appropriate state supervisory authority (SSA)
(5702.206.) For PCA purposes, the regulation refers to a new credit union’s
equivalent of a NWRP as a revised business plan (5702.304(a)(2)).
New credit union. A credit union that has been in operation for less than 10
years and has $10 million or less in total assets (5702.2(h)). NCUA may classify
a credit union that exceeds $10 million in total assets as new if its total assets
subsequently decline to $10 million or below while it is within its operational
limit of less than 10 years (5702.301(b)). NCUA may deem a credit union
formed as a result of a spin off of a group from the field-of-membership (FOM)
of an existing credit union to be in operation since the effective date of the spin
off. A credit union whose total assets decline to $10 million or below as a result
of a spin-off group within its FOM is deemed to be new if it has been in
operation less than 10 years (§702.301(c)).
Retained earnings. Retained earnings consist of undivided earnings, regular

reserves, and any other appropriations designated by management or regulatory
authorities. An appropriation of undivided earnings consists of a set aside of
such an account, e.g., the regular reserve. Items of retained earnings must flow
naturally through the income statement.
Risk-based net worth requirement. Additional net worth necessary to

compensate for material risks against which the 6 percent net worth ratio does
not provide adequate protection. The computation of a credit union’s RBNW
requirement uses the standard calculation of $702.106. A credit union may
substitute one or more alternative components in place of the corresponding
standard components (5702.107.)
0 Spin-off credit union. A newly-chartered credit union formed from a group

from the field of membership of an existing credit union (§702.301(c)).
Total assets. For each quarter, a credit union must elect a measure of total assets
from the choices below to apply for PCA purposes. The credit union will use this
measure of total assets for all of the quarterly PCA calculations, except the risk-
based net worth requirements. ($702.103 - 5702.106, §702.201(a)).
- Average quarterly balance - the average of quarter-end balances of the four

most recent calendar quarters;
- Average monthly balance - the average of month-end balances over the
three calendar months of the calendar quarter;
- Average daily balance - the average daily balance over the calendar quarter;
- Quarter-end balance - the quarter-end balance of the calendar quarter as
reported on the credit union’s call report.
If the credit union elects one of the alternative methods to compute its
NWR, it must also use this total assets election for purposes of computing
the reserve transfer amount for the current quarter. For example, if the credit
union chooses average daily assets, it must use 0.1 percent of average daily
assets for its reserve transfer. Or, if the credit union makes no optional total
Page 17/1-4
assets election, by default its transfer amount will be 0.1 percent of quarter-
end total assets.
Net Worth The net worth calculation for credit unions is as follows:
Calculation
Net Worth Ratio = Net Worth/Total Assets
A credit union with assets over $10 million must also perform a
RBNW calculation to determine if the credit union has an applicable
RBNW requirement as described in the Risk-Based Net Worth
Requirement section of this chapter.
The following items further describe the net worth calculation and its
importance in the examination process:
Net worth numerator. For purposes of the net worth ratio, the
numerator is the credit union’s net worth at quarter end. CUMAA
defines net worth generally as GAAP retained earnings. The
Definitions section of this chapter contains a definition of both net
worth and of retained earnings. Net worth includes amounts the
credit union had previously closed from net income into undivided
earnings. If the credit union does not close its net income into
undivided earnings during interim periods, examiners will treat the
net income as if it had been closed into undivided earnings.
Net worth denominator. The definition of “total assets” in the

Definitions section of this chapter contains the methods available
for determining total assets for the purposes of the net worth ratio.
Each quarter, credit unions elect which method of determining total
assets they will use to calculate the net worth ratio and, if
applicable, the earnings transfer and asset growth restriction. The
total asset measurement selected also applies to the determination
of whether or not a credit union falls within the definition of
“new.” A credit union need not maintain consistency from one
period to the next in its choice of method for determining total
assets; it has the option of choosing the most favorable method
each quarter. Absent an election by the credit union, NCUA will
use quarter-end total assets as the default.
Page 17/1-5
EXAMINER’S GUIDE
Net worth documentation. Responsibility for calculating the net

worth ratio at the end of each calendar quarter falls on the
individual credit union. The call report contains the PCA Net
Worth Calculation worksheet. It automatically computes the credit
union’s net worth ratio and provides the net worth classification
(5702.106.) All credit unions must determine their net worth
calculations at the end of each quarter and retain the calculation
documentation.
Effective date. The effective date of the net worth classification is

the most recent of the following:
- The last day of the calendar month following the end of the
calendar quarter (quarter-end effective date); or
- The date the credit union’s net worth ratio is recalculated by, or
as a result of, its most recent final examination report
(corrected net worth category); or
- The date the credit union received written notice from NCUA
or the SSA of reclassification to a lower net worth category,
based on safety and soundness grounds (reclassificationto
lower category) (§702.1Ol(b)).
Examination verification. Quarter-end net worth ratio calculations

provide the basis for PCA requirements because credit unions are
only required to compute their net worth ratio at quarter-end.
To verify accuracy, examiners should recalculate the net worth

ratio reported on the call report using the credit union’s chosen
“total assets” as of the most recent quarter end.
If the recalculation process discloses a quarter-end calculation error

made by the credit union and correcting that error would place the
credit union in a lower net worth category, the effective date of the
lower net worth classification will be the date the examiner gives
the final examination report to the officials. However, the corrected
net worth category effective date cannot precede the quarter-end
effective date. For example, if the examiner delivers the
examination report with the new corrected year-end net worth ratio
on January 15, the effective date of the net worth classification
Page 17/1-6
would be January 3 1. If the examiner delivers the report on

February 15, the effective date will be February 15.
In addition, if the examiner discovers errors, omissions or other

findings that would result in a lower net worth ratio, but the source
of these events took place after the most recent quarter-end net
worth ratio measurement period, the net worth ratio will not reflect
these modifications until the credit union’s next quarter-end
measurement date.
When an examiner computes a net worth ratio as of the effective

date of the exam, and that date follows the most recent quarter-end
effective date, the net worth ratio only indicates what the credit
union’s net worth ratio and corresponding net worth classification
might be as a result of the credit union’s next quarter-end
measurement.
0 Assigning a capital component rating. For examinations other than

quarter end, examiners should also calculate the net worth ratio
using the month-end balance of net worth to the month-end balance
of total assets as of the examination date. If the examination date
falls on a quarter end, then the examiner should use the same total
asset calculation as the credit union.
If a material difference exists between the credit union’s chosen

method at the quarter end and the calculation made by the
examiner as of the examination date, the examiner should discuss
in the examination report the reasons for the difference and assign
an appropriate capital component rating.
0 Safety and soundness classification. Examiners may not reclassify

a credit union to a lower net worth category for safety and
soundness reasons. Only the NCUA Board may reclassify the
credit union based on safety and soundness concerns
(§702.101(b)(3)).
Page 17/1-7
EXAMINER'S GUIDE
Statutory Net Other Than New Credit Unions New Credit Uni Ins
Net Worth
Worth Ratio
Categories 7% or greater
6% to 6.99%
3.5% to
5.99%
2% to 3.49%
0% to 1.99%
Less than 0%
Undercatitahzed
Critically
UndercaDitalized I Lessthan2%
*Also must meet applicable risk-based net worth requirements
Illustration 17-A
Illustration 17-A shows the net worth categories for all credit unions.
The left side illustrates net worth categories for credit unions other
than those defined as new. The right side shows net worth categories
for credit unions defined by statute as new (in operation for less than
10 years and assets of $10 million or less.)
Reasonable Timetable to Build Net Worth

I Within # of Years in Operation I Net Worth Ratio 1
3 Years 0% to 1.99%
5 Years 2% to 3.49%
7 Years 3.5% to 5.99%
10 Years 6% to 6.99%
Illustration 17-B
New credit unions initially have no net worth and, as such, need
reasonable time in which to accumulate it. Illustration 17-B is a
reasonable timetable for building net worth and serves only as a guide
to show the anticipated time for a new credit union to reach the net
worth classification of adequately capitalized.
Net Worth All credit unions complete a call report each quarter. Therefore, other than
Category filing a call report, a federally insured credit union need not notify the
Change NCUA Board of a change in its net worth ratio that places the credit union in
a lower net worth category.
~~~~
Page 17/14
Reclassification The NCUA Board has the discretion to reclassify a credit union to the
next lower category if the credit union has an unsafe or unsound
condition or engages in material unsafe and unsound practices. The
NCUA Board may reclassifl a well-capitalized credit union as
adequately capitalized, and may require an adequately capitalized or
undercapitalized credit union to comply with certain mandatory or
discretionary supervisory actions as if it were in the next lower
category. The NCUA Board may apply this same discretionary
authority to reclassifl new credit unions that are well, moderately, or
marginally capitalized. The NCUA Board alone has this authority; they
may not delegate it. However, credit unions may apply to the NCUA
Board for reconsideration of its decision.
PCA requires reclassification to significantly undercapitalized if a

credit union in the second-tier undercapitalized category (4.00 percent
to 4.99 percent net worth ratio) fails to (1) submit a NWRP within the
regulatory timeframes, or (2) implement an approved NWRP.
Mandatory Mandatory Supervisory Actions

Supervisory
Actions Adequately Under Significantly Under
Capitalized Capitalized Under Capitalized Capitalized
NW Ratio = NW Ratio = NW Ratio = NW Ratio =
MSA 6% to 6.99% 4% to 5.99% 2% to 3.99%
Earnings
i
Transfer X X X
Net Worth
Restoration
Plan X X
Restrict
Asset
Growth X X
Restrict
MBLs X X
Illustration 17-C
Credit unions other than those defined as new. Well-capitalized

credit unions are those with net worth ratios equal to, or above, 7
percent and meet applicable RBNW requirements. No MSAs or DSAs
apply to these credit unions. However, less than well-capitalized credit
unions must comply with the mandatory and discretionary actions
prescribed by CUMAA.
Page 1711-9
EXAMINER'S GUIDE
Illustration 17-C shows the MSAs and the categories of credit unions
to which each applies. The same MSAs apply to undercapitalized,
significantly undercapitalized, and critically undercapitalized
categories.
0 Earnings transfer. For credit unions that are less than well
capitalized, CUMAA requires annual earnings retention of 0.4
percent or more of their total assets. Credit unions will use the
regular reserve account as an appropriation of undivided earnings
for the earnings retention. Beginning with the effective date of net
worth classification below well capitalized, the credit union will do
the following until it reaches the well-capitalized category
(s702.201(a)):
- Increase the dollar amount of net worth quarterly by at least 0.1

percent of total assets; and
- Transfer that amount to regular reserve.
Reserve transfers in the absence of an increase in the dollar amount

of net worth do not satisfy the requirement. (Also, the credit union
will not credit undivided earnings to recover the provision for loan
and lease losses expense.)
NCUA may permit, on a case-by-case basis, a reduction in earnings

transfer to avoid significant redemption of shares and to further the
purpose of PCA (5702.201(b)). However, only under exceptional
circumstances should NCUA allow a reduction below zero
(resulting in net losses) for more than four consecutive calendar
quarters. In these cases, documentation should include how NCUA
expects the credit union to return to profitability in the near-term
following this period.
NCUA cannot accept requests received after the quarter-end for

reductions in the minimum earnings transfer requirement.
0 NWRP. Credit unions must submit a NWRP (described later in

this chapter.)
Restrict increase in assets. Beginning with the effective date of

the net worth classification, the credit union cannot increase its
Page 17/1-10
assets beyond its total assets for the preceding quarter, except in
the following circumstances:
- The credit union’s asset growth and net worth are increasing
consistent with an approved NWRP, or
- If NCUA has not yet approved the credit union’s NWRP (the
credit union may be awaiting initial approval) and the credit
union’s total assets are increasing as a result of increases in the
following accounts used in normal operations:
i. Total accounts receivable and accrued income on loans

and investments;
ii. Total cash and cash equivalents; and
iii. Total loans outstanding, not to exceed the sum of total
assets plus the quarter-end balance of unused
commitments to lend and unused lines of credit.
These exceptions to the asset growth restriction are available to the

credit union while waiting for approval of its initial NWRP,
provided the credit union does not offer rates on shares in excess of
prevailing rates on shares and deposits in its relevant market area
and does not open any new branches. However, the credit union
may not retroactively restrict dividend rates already declared on
shares acquired before imposing the restriction.
0 Restrict member business loans. Beginning with the effective

date of net worth classification, the credit union cannot increase the
total dollar amount of its member business loans (MBLs), defined
as loans outstanding and unused commitments to lend, as of the
prior quarter-end, unless the credit union:
- Was chartered for the purpose of making MBLs;

- Has a history of primarily making MBLs;
- Has a low income designation; or
- Is a community development credit union.
The restriction applies to the total dollar amount of MBLs. Thus,

the credit union may make new MBLs provided the total dollar
amount of MBLs does not increase (§702.202(a)(3)(ii)(c)).
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EXAMINER’S GUIDE
New credit unions. New credit unions that have less than 6 percent
net worth, or were reclassified to moderately capitalized or lower, are
subject to MSAs. In addition, MSAs apply to a new credit union that
either (1) remains uncapitalized beyond the time period provided in its
initial business plan (approved at the time the credit union was
chartered); or (2) subsequently declines to uncapitalized from a higher
category after expiration of the time period originally approved in its
initial business plan for the credit union to operate in the uncapitalized
category. The MSAs for new credit unions differ slightly from those
prescribed for other credit unions:
0 Earnings transfer. New credit unions must increase net worth and
make quarterly earnings transfers to the regular reserve account in
an amount reflected in the credit union’s previously approved
initial or revised business plan (may be less than the equivalent of
0.4 percent of assets per year.)
0 Submit a revised business plan. New credit unions will submit a

revised business plan if any of the following apply:
- The credit union’s net worth ratio has not increased consistent
with its currently approved business plan;
- The credit union has no currently approved business plan; or
- The credit union has failed to undertake any mandatory actions
(s702.304.)
0 Restrict member business loans. New credit unions may not

increase the total amount of member business loans (defined as
loans outstanding and unfunded commitments to lend) unless it
meets one of the exceptions of §702.202(a)(4.)
Discretionary CUMAA required NCUA to develop DSAs to complement the

Supervisory CUMAA-prescribed mandatory actions. To further the purpose of
Actions PCA, NCUA developed fourteen DSAs, which are comparable to the
discretionary safeguards in the banks’ system of PCA. (For a detailed
explanation of the internal DSA implementation process, please see
Instruction entitled Discretionary Supervisory Actions (DSAs) under
Prompt Corrective Action (PCA)).
Page 17/1-12
Discretionary Supervisory Actions

Significantly Critically
Under Under
Capitalized Capitalized
NW Ratio = NW Ratio =
DSA 2% to 3.99% Less than 2%
Approval for
acquisitions X X
Restrict
transactions
with CUSO X X
Restrict
dividend X X X
No or reduce
asset wowth
Terminate
risky activity X X
No non-
member
deposits X X
Dismiss
officer or
director X X
Employ
qualified
officers X X
Restrict or
require other
actions X X
New election
of directors X X
Restrict
I X ,
r
compensation X
Require
merger X
Restrict
payments on
secondary
capital
NCUA
approval for
operations
Illustration 17-D
x
Illustration 17-D displays the DSAs available in the undercapitalized
(the first nine DSAs apply to second tier undercapitalized credit
unions), significantly undercapitalized, and critically undercapitalized
No DSAs will apply to first-tier undercapitalized credit unions as long as the credit
union is in compliance with all MSAs and is implementing an approved NWRP.
Page 17/1-13
EXAMINER’S GUIDE
net worth categories for credit unions other than those defined as new.
One or more of the fourteen actions may apply to new federally
insured credit unions with a net worth of less than 6 percent if they (1)
fail to meet their quarterly net worth targets, or (2) fail to undertake
any MSAs, regardless of their net worth classification (§702.304(b)).
The undercapitalized category is divided into two tiers. First-tier

undercapitalized credit unions have a net worth ratio of 5 percent to
5.99 percent. Nine of the fourteen discretionary actions are available
against second-tier undercapitalized credit unions, which have net
worth ratios of 4 percent to 4.99 percent. Credit unions classified as
first-tier undercapitalized are subject to the second tier DSAs only if
they (1) fail to comply with any of the MSAs, (2) fail to implement an
approved NWRP in a timely manner, or (3) fail to meet the timetable
of net worth targets in the plan for increasing net worth.
All of the DSAs applicable to the second-tier undercapitalized,

significantly undercapitalized, and critically undercapitalized credit
unions give NCUA authority to require the actions described below.
The DSAs are indexed to specific net worth categories described
below and shown on Illustration 17-D. (Examiners should review the
delegations of authority to determine who can take the action.)
0 Require prior approval for acquisitions, branching, or new

lines of business. NCUA can prohibit a credit union from (directly
or indirectly) acquiring an interest in a business entity or financial
institution, establishing or acquiring an additional branch office, or
engaging in a new line of business. However, these prohibitions
will not go into effect if NCUA has approved the credit union’s
NWRP, the credit union is implementing its plan, and NCUA
determines that the proposed action is consistent with and will
further the objectives of that plan.
Restrict transactions with and ownership of CUSOs. NCUA

can restrict the credit union’s transactions with a CUSO or require
the credit union to reduce or divest its ownership interest in a
cuso.
0 Restrict dividends or interest the credit union pays to market
rates. NCUA can restrict a credit union’s dividend or interest rates
Page 17/1-14
on shares to the prevailing rates for comparable accounts and

maturities in the relevant market area, as determined by NCUA.
However, dividend rates already declared on shares acquired
before imposing the restriction may not be retroactively restricted.
Prohibit asset growth or reduce the assets generally or in a

particular asset category. NCUA can prohibit any growth in the
credit union’s assets or in a category of assets, or require the credit
union to reduce its assets or a category of assets.
0 Alter, reduce, or terminate excessively risky activity by the

credit union or CUSO. NCUA can require the credit union or its
CUSO to alter, reduce, or terminate any activity that poses
excessive risk to the credit union.
0 Prohibit non-member deposits. NCUA can prohibit the credit

union from accepting all or certain nonmember deposits.
0 Dismiss directors or senior executive officers. NCUA can

require the credit union to dismiss from office any director or
senior executive officer. However, a dismissal under this clause
shall not be construed to be a formal administrative action for
removal under 12 U.S.C. §1786(g.)
0 Employ qualified senior executive officers. NCUA can require

the credit union to employ qualified senior executive officers (who,
if NCUA so specifies, shall be subject to its approval.)
Implement other actions to carry out the purpose of PCA.

NCUA can restrict or require such other action by the credit union
if that action will cany out the purpose of PCA better than the
actions mentioned in this section.
0 Require a new election of directors. NCUA can order a new

election of the credit union’s board of directors.
0 Require prior approval for senior executive officers’

compensation and bonus. Unless the credit union obtains the
prior written approval of the NCUA Board, NCUA can impose the
following:
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EXAMINER’S GUIDE
- Limit compensation for any senior executive officer to that

officer’s average rate of compensation (excluding bonuses and
profit sharing) during the four quarters preceding the effective
date of classification as significantly or critically
undercapitalized; and
- Prohibit payment of a bonus or profit share to such officer.
0 Require a merger if grounds exist for conservatorship or

liquidation. NCUA can require the credit union to merge with
another financial institution if one or more grounds exist for
placing the credit union into conservatorship pursuant to 12 U.S.C.
§ 1786(h)(l)(F), or into liquidation pursuant to 12 U.S.C.
§ 1787(a)(3)(A)(i.)
0 Restrict payment of principal or interest on uninsured

secondary capital of low-income designated credit unions.
Beginning 60 days after the effective date of classification of a
low-income credit union as critically undercapitalized, NCUA can
prohibit payments of principal, dividends, or interest on the credit
union’s uninsured secondary capital accounts established after
August 7,2000. However, unpaid dividends or interest shall
continue to accrue under the terms of the account to the extent
permitted by law.
Approve certain operational level activities. NCUA can require

a critically undercapitalized credit union to obtain NCUA’s prior
written approval before doing any of the following:
- Entering into any material transaction not within the scope of

an approved NWRP (or approved revised business plan);
- Extending credit for transactions deemed highly leveraged by
the NCUA Board or, if state-chartered, by the appropriate state
official;
- Amending the credit union’s charter or bylaws, except to the
extent necessary to comply with any law, regulation, or order;
- Making any material change in accounting methods; and
- Paying dividends or interest on new share accounts at a rate
exceeding the prevailing rates of interest on insured deposits in
its relevant market area.
Page 17/1-16
Appeals NCUA has implemented an independent appeals process by which

Process credit unions and dismissed officials, affected by PCA, can challenge
material supervisory decisions by NCUA staff. DSAs qualifl as such
material supervisory decisions (s747.2002 and 5747.2004.)
CUMAA requires that the NCUA Board provide advance notice and
an opportunity for a credit union to be heard before imposing a DSA,
unless such an action is necessary to further the purpose of PCA. The
credit union could challenge the proposed DSA in writing and request
that the action be modified or not imposed. The credit union is not
entitled to a hearing before the NCUA Board. The NCUA Board, or an
independent person designated by the Board, may then decide not to
issue the directive or to issue it as proposed or modified (s747.2002.)
The credit union may seek the NCUA ombudsman’s recommendation
regarding a proposed DSA.
When a credit union must dismiss a director or senior executive

officer, the NCUA Board must serve the dismissed person with a copy
of the directive issued to the credit union accompanied by a notice of
the person’s right to seek reinstatement by the NCUA Board. Only that
person may then challenge the dismissal and request reinstatement.
That person also may request an informal hearing and the opportunity
to present witness testimony. The dismissal remains in effect while the
request for reinstatement is pending (s747.2004.) While the credit
union may challenge the proposed DSA, the credit union may not seek
reinstatement after the person is dismissed.
Discretionary The NCUA Board has the discretionary authority to place a

Conservator- significantly undercapitalized federally-insured credit union or a credit
ship or union meeting the definition of new that is classified as moderately
Liquidation capitalized or lower into conservatorship or liquidation, provided the
credit union has no reasonable prospect of becoming adequately
capitalized (§702.203(c) and 5702.304 (c)). This includes the NCUA
Board’s reclassification of a credit union to significantly
undercapitalized on safety and soundness grounds (§702.102(b)).
A credit union placed into conservatorship retains the right to

challenge the decision in court within 10 days. A credit union placed
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EXAMINER'S GUIDE
into liquidation under PCA can directly appeal to the NCUA Board;
however, CUMAA gives the credit union no right to judicial review.
Mandatory Non-new credit unions. Following are mandatory conservatorship and

Consenrator- liquidation requirements for credit unions that do not meet the
ship, definition of a new credit union:
Liquidation,
or Other 0 The NCUA Board must place a credit union into conservatorship
Corrective or liquidation within 90 calendar days after being classified
Action (OCA) critically undercapitalized, regardless of the credit union's prospect
of becoming adequately capitalized; or
0 The NCUA Board may take other corrective action (OCA) in lieu
of conservatorship or liquidation. §702.204(c.)
Generally, OCA will consist of adherence to quarterly steps and targets

in an approved NWRP. The OCA plan should pose the least possible
long-term loss to the NCUSIF. OCA may also consist of allowing the
credit union time to arrange and complete a merger under NCUA
supervision.
OCA Renewal OCA can range from a period of 1 to 180 days, and will expire unless
renewed prior to expiration, regardless of the time limit of any
previously approved NWRP. If the credit union remains critically
undercapitalized and NCUA does not renew OCA, the NCUA Board
generally will immediately place the credit union into conservatorship
or liquidation. $702.204(~)(2.)
The statutory 18-month maximum period for OCA to succeed

effectively limits renewals of OCA that extend the full 180-day period
(§702.204(c)).
Limitation on The NCUA Board must conserve or liquidate a surviving critically

OCA undercapitalized credit union, regardless of the impact of OCA, if that
Renewals credit union is critically undercapitalized (less than 2 percent net worth
ratio) on average for a full calendar quarter beginning 18 months from
the effective date it first was classified critically undercapitalized. This
Page 17/1-18
is true even if the credit union surpasses a 2 percent net worth ratio for
any preceding period during the 18-month period. The effective date
when a credit union first becomes critically undercapitalized almost
always falls one month after the end of a calendar quarter.
Thus, the last possible day for OCA will be no more than 23 months
(23 months x 30 days =690 days) from the effective date the credit
union first became critically undercapitalized (18 calendar months
from the effective date, plus two months to the end of the calendar
quarter at the end of the 18-month period, plus the subsequent three
months of the next calendar quarter), absent an exception. (See
Illustration 17-E for an example of a mandatory conservatorship or
liquidation timetable.)
Sample Mandatory Conservatorship or Liquidation

Action Date Event
12/31/XO Credit union becomes critically undercapitalized
(net worth<2%)
1/31/X1 Effective date of net worth classification
Option of 2/1/X1 18 months begins-
Liquidation or First 90 days,
Conservatorship Then 180 day periods
7/3 1/X2 I 18 months ends
10/1/X2 I Full calendar quarter after 18 months begins
I 12/31/X2 I Full calendar quarter ends-credit union still I
critically undercapitalized
Mandatory l/l/X3 23 months after effective date of net worth
Illustration 17-E
Because of this statutory deadline, NWRP and Plans for Special

Assistance to return the credit union to a 2 percent net worth ratio
cannot extend beyond a total of 23 months from the effective date of
classification as critically undercapitalized.
As legally authorized, the NCUA Board delegated authority to regional

directors to initiate and renew OCA in lieu of conservatorship or
liquidation for credit unions with assets less than $5 million. The
NCUA Board cannot delegate OCA authority for credit unions of $5
million in assets or greater. Therefore, if a credit union has assets of $5
million or greater, the regional director first must obtain concurrence
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EXAMINER'S GUIDE
for OCA from the Office of Examination and Insurance and then
approval from the NCUA Board.
OCA Support for the approval of OCA should include the following items:
Documentation
0 Board Action Memorandum (BAM), or memo to the NCUA Board
Secretary (if applicable);
0 Memo to the Director of the Office of Examination and Insurance
recommending OCA approval (if applicable);
0 Memo to the regional director recommending OCA approval;
0 Regional summary;
0 NWRP;
0 Regional Director Letter to the credit union informing them of
OCA approval; and
0 Other supporting financial information at the regional director's
discretion such as Financial Performance Reports (FPRs),
examination workpapers; financial statements, consolidated
balance sheets, time frames, etc.
Exception to NCUA may avoid mandatory liquidation of a credit union only if, after
Mandatory the 23 months, the NCUA Board certifies that the credit union has met
Liquidation the following three criteria for an exception to liquidation:
0 The credit union has, since the date of approval, substantially

complied with a NWRP requiring improvement in net worth;
0 The credit union has positive net income or a sustainable upward
trend in earnings; and,
0 The credit union is viable and not expected to fail.
NCUA will not routinely grant this exception. In helping credit unions
develop NWRPs and in reviewing NWRPs, examiners should not
assume the granting of this exception.
Since the NCUA Board must recertify the three exception criteria
quarterly, examiners will review the status of critically
undercapitalized credit unions at least quarterly. If NCUA cannot
recertify the credit union, the NCUA Board must then place the credit
union into liquidation ($702.204(~)(3)(iii)).
Page 17/1-20
New credit unions. The NCUA Board must place a new credit union
classified as uncapitalized into conservatorship or liquidation based on
either of the following criteria:
The credit union failed to submit a revised business plan within 90

days of the effective date of its classification as uncapitalized; or,
0 The credit union remains uncapitalized 90 days after the NCUA

Board approved the revised business plan submitted by the credit
union as required above, unless, the credit union documents to the
NCUA Board why it is viable and has a reasonable prospect of
becoming adequately capitalized. Generally, the credit union’s
success in meeting the plan’s financial goals will support this
exception.
Consultation NCUA will work cooperatively with the appropriate SSA before
with SSA imposing any DSAs on a federally insured, state chartered credit union
(FISCU), and will provide the SSA with prompt notice of its decision.
Before placing a FISCU into conservatorship, NCUA will contact the

appropriate SSA and will give that SSA the opportunity to place the
credit union into conservatorship or liquidation. If the SSA requests,
NCUA will provide, in writing, the reasons for the proposed
conservatorship or liquidation along with a reasonable time period for
the SSA to respond. If the SSA responds within the time period and
disagrees with the proposed conservatorship or liquidation and gives
reasons for that disagreement, NCUA will not place the credit union
into conservatorship or liquidation unless the NCUA Board determines
that the credit union poses a significant risk of loss to the NCUSIF and
NCUA expects conservatorship or liquidation to reduce the risk of loss
or the expected loss.
Net Worth Credit unions that do not meet the definition of new. The NWRP
Restoration serves as a blueprint to the credit union’s officials and staff for
Plan restoring the credit union’s net worth ratio to 6 percent or greater.
Undercapitalized federally insured credit unions (net worth ratio less
than 6 percent or less than the RBNW requirement) must submit their
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EXAMINER’S GUIDE
NWRPs to the appropriate regional director and, if state chartered,

concurrently to their SSA (5702.206.)
Responsibility for developing a NWRP rests with the credit union’s

officials and staff. In developing its NWRP, the credit union must state
specific goals and objectives based on reasonable assumptions,
financial trends, and projections. The officials must propose the length
of time they will need to implement the plan and obtain the intended
results. To receive approval, the plan must meet the minimum criteria
set forth in §702.206(c) including:
0 A quarterly timetable of steps necessary to increase the credit

union’s net worth ratio to adequately capitalized by the end of the
NWRP’s term, and to remain adequately capitalized for an
additional four consecutive quarters;
0 The projected earnings transfer to the regular reserve each quarter

during the term of the NWRP. This transfer must equal at least
l/lOth of one percent (0.1 percent) of the credit union’s total
assets, or such lesser amount as the regional director may permit,
provided that on an annual basis the transfer must not be less than
zero (§702.201(a) and §702.201(b));
0 Plans for complying with the MSAs and DSAs imposed on the
credit union by the regional director under Subpart B;
Types and levels of activities in which the credit union will engage;
0 Steps necessary to correct the unsafe and unsound practices or

conditions if the credit union has been reclassified to a lower
category (§702.102(b));
0 Pro forma financial statements including any off-balance sheet

items covering a minimum of the next two years; and
0 Any additional information that the regional director or the SSA

may require.
An undercapitalized credit union must file an NWRP within 45 days of

becoming undercapitalized (net worth less than 6 percent or less than
Page 17/1-22
the RBNW requirement), unless it was reclassified as undercapitalized

solely on safety and soundness grounds. If a credit union has an
approved NWRP in place, and the credit union’s net worth category
changes (e.g., slips to a lower net worth category), it need not submit a
new NWRP unless required to do so by the regional director.
The regional director may extend a filing deadline. If a credit union’s

net worth category changes and the regional director requires that it
file a new NWRP, the credit union has 30 calendar days in which to do
so, unless the regional director extends that period. The regional
director will provide notification to credit unions that fail to file a
required NWRP within the required timeframes. The credit union must
file its NWRP within 15 calendar days of receiving the notification
(§702.206(a)).
The regional director has 45 calendar days to review the NWRP and to
provide written notice of approval or disapproval of the plan. If the
credit union receives no decision within 45 days, the NWRP is deemed
approved. If the regional director disapproves the plan, it will provide
the credit union with its reasons. The credit union must then submit a
revised NWRP within 30 days of receiving the regional director’s
notice of disapproval unless the regional director sets a different
period. The regional director must respond within 30 days regarding its
approval or disapproval of the credit union’s revised NWRP
(§§702.206(f) and 702.206(g)).
Appendix 17B contains a sample NWRP format.
Revised New credit unions. New credit unions categorized as moderately,

Business Plans marginally, or minimally capitalized must file a revised business plan
with the appropriate regional director and SSA, if state chartered, for
review and approval. The credit union must file the plan within 30
calendar days of the effective date that (1) it fails to meet a quarterly
net worth target of its current approved business plan, (2) it has no
current approved business plan, or (3) it has failed to undertake any
MSAs.
If a new credit union becomes uncapitalized or remains uncapitalized

beyond the period approved in its initial business plan, it must file a
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EXAMINER’S GUIDE
revised business plan within 90 days, or a shorter timeframe prescribed

by NCUA. The revised business plan must provide for an alternative
means of funding the credit union’s earnings deficit. In either case,
NCUA can extend the filing deadlines by providing notice to the credit
union of a different period (§702.305(a)(2)).
The following requirements apply to the revised business plan:
0 It must be based on realistic assumptions;

0 It must have the expected result of restoring the credit union’s net
worth; and
It must not expose the credit union to an unreasonable increase in
risk.
To meet the minimum criteria receive approval set forth in

§702.306(b), the plan must:
0 Analyze changes since the new credit union’s current business plan
was approved in any of the business plan elements required for
charter approval under Chapter 1, Section IV.D, of NCUA’s
Chartering and Field of Membership Manual, IRPS 99-1, as
amended, or for state chartered credit unions under applicable state
law;
0 Establish a timetable of quarterly targets for net worth during each

year in which the revised business plan is in effect, so that the
credit union becomes adequately capitalized and remains so for
four consecutive quarters;
Specify the projected amount of earnings that the credit union will
transfer quarterly to its regular reserve (§702.304(a)(1) or
§702.305(a)( 1));
0 Explain how the new credit union will comply with the MSAs and
DSAs;
0 Specify the types and levels of activities in which the credit union
may engage;
Page 17/1-24
Specify the steps a new credit union, reclassified to a lower

category, will take to correct the unsafe or unsound condition or
practice (§702.302(d)); and
0 Include such other information as the NCUA Board may require.
The regional director must provide notification to a new credit union

that fails to file a required revised business plan within the timeframes
allowed. The credit union must then file its revised plan within 15
calendar days of receiving the notification.
The regional director must review the revised business plan and
provide written notice within 30 calendar days regarding its approval
or disapproval. In the event of disapproval, the notice must provide the
reasons for disapproval. If the regional director makes no decision
within 30 days, the revised business plan is deemed approved. If
disapproved, the credit union must submit a revised plan within 30
days from receiving the regional director’s notice of disapproval,
unless the regional director sets a different period.
The regional director then has 30 days to approve or disapprove the

revised plan. In addition, a credit union may amend a previously
approved revised business plan. Until the regional director approves
the amended plan, the credit union must implement its previously
approved revised business plan. The regional director will consult with
the SSA regarding the approval or disapproval of new, revised, or
amended revised business plans for state chartered credit unions
((§§702.306(e)-(g)).
NWRP and The regional director, in consultation with the SSA (for state chartered
Revised credit unions), must approve the credit union’s NWRP or revised
Business Plan business plan. During the approval process, the regulatory authority
Ap provaI will consider the following:
0 Compliance with minimum criteria;

0 Probability of meeting realistic assumptions; and
0 Probability of unreasonably increasing exposure to risk, including
credit risk, interest rate risk, or other risks.
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EXAMINER’S GUIDE
Examiners’ On- After the regional director has approved the NWRP and the credit
Going Review of union has implemented it, regional policy will dictate review and
NWRP monitoring of the plan. The NWRP questionnaire in AIRES provides
guidance on areas that require the examiners’ review. Examiners
should discuss the credit union’s progress with management during the
examination and, if necessary, during on- and off-site supervision of
the credit union. For as long as a credit union has an NWRP in place,
examiners should document the credit union’s progress in meeting the
terms of the NWRP, as well as any changes made to the NWRP, in the
examination report (e.g., Supplementary Facts section.)
During the review, examiners should assess the plan’s adequacy and
implementation and should discuss with the officials any ofthe goals
or objectives that the credit union did not meet. If examiners continue
to have concerns about the credit union’s ability to meet its NWRP
goals, they should document the concerns and recommend corrective
action in the examination report.
Plan Changes A credit union may also amend a previously approved NWRP. The
officials must submit the revised plan to the regional director and SSA
(if a state-chartered credit union) for re-approval. The credit union
need not submit an additional NWRP due solely to a change in net
worth category (including reclassification under §702.102(b)), unless
the regional director notifies the credit union that it must submit a new
NWRP. The regional director will consult with the appropriate SSA
regarding the approval or disapproval of new, revised, or amended
NWRPs in state chartered credit unions (§702.206(f)(3)). Until NCUA
approves the proposed amended NWRP, the credit union must
implement the previously approved plan.
When a credit union receives notification from NCUA that it must

submit a new or revised NWRP, the credit union must file the new
NWRP, in writing, with the appropriate regional director and SSA
within 30 calendar days of receiving the notice. However, the regional
director can notify the credit union in writing that the credit union may
file the NWRP within a different period.
Page 17/1-26
Assistance In Responsibility for developing a NWRP rests with the credit union’s
Preparing Plan officials and staff. However, NCUA can assist a credit union in
preparing an NWRP or, for new credit unions, a revised business plan.
By statute, a credit union having assets less than $10 million and net
worth less than 6 percent will receive NCUA’s assistance in preparing
its NWRP, if it requests such assistance. This extends to other than
new credit unions that were reclassified under §702.102(b) to a lower
category if the regional director has required the credit union to
develop a NWRP. (Examiners can provide similar assistance during
the examination and supervision contacts to credit unions that do not
meet these criteria, if so directed by regional policy.) Credit unions
needing assistance must submit their requests to the applicable
regional director in ample time for the process to meet the regulatory
timeframes (s702.206 and s702.306.)
NCUA or SSA examiners may provide guidance to the credit union’s

officials and staff in preparation of the NWRP. The NCUA Board
intends that the NCUA or SSA examiners will be the primary resource
for providing this guidance.
When the credit union requests examiner assistance, the request must
document the credit union’s eligibility for the assistance requested.
Also, if the credit union needs additional time to complete and submit
its NWRP, it must request an extension of the regulatory timeframe
(s702.206 and s702.306.)
New credit unions. NCUA will not provide assistance for preparing
the initial business plan required for new credit unions applying for
initial charter approval; however, NCUA’s economic development
specialists often aid credit unions in developing their initial business
plans. New credit unions must meet the following criteria to qualify for
NCUA assistance in providing guidance in the preparation of their
revised business plans:
0 They are not meeting the net worth goals set forth in their current
business plans; and
0 They have a net worth ratio of less than 6 percent.
Page 17/1-27
EXAMINER’S GUIDE
Examiner While the examiner may facilitate discussion about the assistance
Assistance needed by the credit union, the examiner will not make business
decisions for the credit union regarding the NWRP. Examiners will
provide assistance by answering the credit unions’ questions, providing
guidance, and giving support.
Regional policy dictates the procedures credit unions may use to obtain
examiner assistance for preparing the NWRP. Clearly, however, the
request should come from the credit union. For this reason, the
chairman of the credit union’s board of directors should sign the
request. State chartered credit unions will make their requests to the
regional director through their SSAs, again allowing ample time to
meet necessary timeframes.
References References
and Federal Credit Union Act
Work papers - Part216
- Part208
- Part206
- Part702
- Section 741.3
- Section 701.34
- Section 747.2002
- Section 747.2004
0 NCUA 5300 Call Report
Guidelines for Submission of an Application for a PCA Risk
Mitigation Credit
Guidelines for Evaluation of an Applications for a PCA Risk
Mitigation Credit
AIRES Net Worth Restoration Plan Checklist
NCUA Letter to Credit Unions: 0 1-CU-0 1 Prompt Corrective
Action (PCA) Implementation Information
Page 17/1-28
Chapter 17 - Part 2
-
PCA RISK-BASED NET WORTH REQUIREMENT
Examination Determine whether the credit union meets the definition of
Objective complex and adheres to the applicable risk-based net worth
(RBNW) requirement
Associated 0 Reputation risk may occur when PCA efforts are not successful
Risks and the credit union fails.
Overview A credit union is defined as complex and a RBNW requirement is

applicable only if the credit union meets both of the following criteria
as reflected in its most recent call report:
0 Minimum asset size. Its quarter-end total assets exceed $10

million; and
0 Minimum RBNW calculation. Its risk-based net worth requirement
as calculated under $702.106 exceeds 6 percent.
Examiners should use the term “applicable RBNW requirement” rather

than “complex.”
All credit unions whose net worth ratio initially places them in either
the adequately- or well-capitalized net worth category (6 percent net
worth ratio and above) must satis@ an applicable RE”requirement,
if the credit union’s quarter-end total assets exceed $10 million.
NCUA will classify a credit union with a 6 percent or higher net worth
ratio in the first tier of undercapitalized, if its applicable RBNW
requirement exceeds its net worth ratio. If it fails to comolv with any
MSA or fails to implement a NWRP within the regulatory timeframes,
such a credit union is subject to all MSAs and any of the second tier
DSAs.
The RBNW requirement also indirectly affects credit unions that have
net worth ratios below 6 percent. These credit unions already must
operate under an approved NWRP. The NWRP must provide the
means and a timetable to reach the adequately-capitalized category.
Page 1712-1
EXAMINER’S GUIDE
However, for credit unions in the undercapitalized or lower net worth

categories, the minimum net worth ratio to the adequately-capitalized
category will be 6 percent or the credit union’s RBNW requirement, if
higher than 6 percent. If the credit union has an applicable RBNW
requirement, the NWRP must prescribe the steps a credit union will
take to reach the RBNW requirement (not just 6 percent.)
The 5300 Call Report contains the standard calculation for the RBNW
requirement (9702.106.) The burden of calculating the RBNW
requirement using alternative components falls on the individual credit
union (9702.107.)
AIRES calculates net worth and the RBNW requirement as of the

examination date. When the AIRES calculation is not as of a quarter
end, the examiner should perform a reasonableness test of the RBNW
requirement calculation. Examiners’ judgment will be important in
determining reasonable accuracy of the RBNW requirement
calculation. In most cases, examiners should not cite minor technical
omissions.
Standard A credit union’s risk-based net worth requirement is the aggregate of

Calculation the standard component amounts shown in Illustration 17-F, each
expressed as a percentage of the credit union’s quarter-end total assets
as reflected in the most recent call report, rounded to two decimal
places.
Illustration 17-F contains the following items:
0 Long-term real estate loans. The sum of:

- 6 percent of the amount of long-term real estate loans less than
or equal to 25 percent of total assets; and
- 14 percent of the amount in excess of 25 percent of total assets;
0 Member business loans outstanding. The sum of:

- 6 percent of the amount of member business loans outstanding
less than or equal to 12.25 percent of total assets; and
- 14 percent of the amount in excess of 12.25 percent of total
assets;
Page 1712-2
PCA - RISK-BASED NET WORTH REQUIREMENT
Standard Calculation of RBNW Requirement

With Risk Portfolios Defined
Amount of risk
portfolio (as percent
of quarter-end total
Risk Assets, liabilities, or assets) to be Risk
portfolio contingent liabilities multiplied by risk weighting
weighting
Long-term Total real estate loans
real estate and real estate lines of
loans credit (excluding MBLs)
with a maturity (or next
rate adjustment period, if 0 to 25.00%
variable rate) greater Over 25.00%
than 5 years
MBLs Member business loans 0 to 12.25%
outstanding outstanding Over 12.25% .14
Investments As defined by federal By weighted average
regulation or applicable life:
State law
>3 years to 10 years .12

>10 years .20
Low-risk Cash on hand and
assets NCUSIF deposit All Yo .oo
Average-risk 100% of total assets
assets minus sum of risk All Yo .06
portfolios above
Loans sold Outstanding balance of
with recourse loans sold or swapped
with recourse, except for All % .06
loans sold to the
secondary mortgage
market with a recourse
I
period of 1 year or less I I
Unused MBL I Unused commitments for I
commitments .06
Allowance
(1 .OO)
A credit union’s RBNW requirement is the sum of eight standard components. A

standard component is calculated for each of the eight risk portfolios, equal to the
sum of each amount of a risk portfolio times its risk weighting. A credit union is
classified “undercapitalized” if its net worth ratio is less than its applicable
RBNW requirement.
Illustration 17-F
Page 1712-3
EXAMINER'S GUIDE
Investments (also see Appendix 17A.) The sum of:

- 3 percent of the amount of investments with a weighted-
average life (as specified in 9702.105) of 1 year or less;
average life greater than 1 year, but less than or equal to 3
years;
average life greater than 3 years, but less than or equal to 10
years; and
average life greater than 10 years;
0 Low-risk assets. Zero percent (0 percent) of the entire portfolio of

low-risk assets;
0 Average-risk assets. 6 percent of the entire portfolio of average-

risk assets;
0 Loans sold with recourse. 6 percent of the entire portfolio of

loans sold with recourse;
0 Unused member business loan commitments. 6 percent of the

entire portfolio of unused member business loan commitments; and
0 Allowance. Negative one hundred percent (-100 percent) of the

balance of the Allowance for Loan and Lease Losses account, not
to exceed the equivalent of 1.5 percent of total loans outstanding.
Alternative A credit union may substitute one or more alternative components in

Calculation Illustration 17-G in place of the corresponding standard components in
Illustration 17-F, when any alternative component amount, expressed
as a percentage of the credit union's quarter-end total assets as
reflected in the most recent call report, rounded to two decimal places,
is smaller.
Illustration 17-G contains the following items:
Page 1712-4
-
P C A RISK-BASED NET WORTH REQUIREMENT
Amount of long-term real estate

loans by remaining maturity Alternative risk weighting
> 5 years to 12 years .08
> 20 years .14
I I
Amount of member business loans

by remaining maturity Alternative risk weighting
Fixed-rate MBLs
0 to 3 years .06
> 5 years to 7 years .I2
> 12 years I .16
Variable-rateMBLs I
0 to 3 years .06
> 12 years .14
Amount of investments by weighted-

average life Alternative risk weighting
0 to 1 year .03
>1 year to 3 years .06
> 10 years .20
Page 1712-5
EXAMINER'S GUIDE
Long-term real estate loans. The sum of:

- 8 percent of the amount of such loans with a remaining
maturity of greater than 5 years, but less than or equal to 12
years;
maturity of greater than 12 years, but less than or equal to 20
years; and
maturity greater than 20 years;
0 Member business loans outstanding. The sum of:

- Fixed rate.Fixed-rate member business loans outstanding as
follows:
6 percent of the amount of such loans with a remaining
maturity of 3 or fewer years;
maturity greater than 3 years, but less than or equal to 5
years;
years;
years; and
maturity greater than 12 years; and
- Variable-rate.Variable-rate member business loans

outstanding as follows:
maturity of 3 or fewer years;
years;
years;
years; and
Page 1712-6
PCA - RISK-BASED NET WORTH REOUIREMENT
(e) 14 percent of the amount of such loans with a remaining

maturity greater than 12 years.
0 Investments. The sum of:

average life (as specified in 5702.105) of 1 year or less;
average life greater than 1 year, but less than or equal to 3
years;
years;
years;
years; and
average life greater than 10 years.
Risk Under $702.108, the NCUA board may grant a risk mitigation credit,
Mitigation which is a credit to reduce an RBNW requirement for a credit union
Credit that fails the standard and alternative calculations for its RBNW, but
can demonstrate mitigation of interest rate risk or credit risk through
other means.
The credit union starts the process for a risk mitigation credit by
applying first to the NCUA regional office and to the SSA (if a state
chartered credit union.) The credit union must demonstrate that the
level of risk exposure to the NCUSIF is less than that indicated by the
RBNW requirement of either the standard or alternative calculations.
The examiner will assess the effectiveness of the reduction of risk

using the NCUA staff publication, “Guidelinesfor Evaluation of an
Applicationfor a PCA Risk Mitigation Credit” available on NCUA’s
Internet website.
Page 1712-7
EXAMINER'S GUIDE
The review should cover the effect of quantitative factors on interest

rate risk and credit risk. Measures that indicate mitigation of risk
include, but are not limited to, net economic value (NEV) analysis or
levels of collateral for loans.
and Federal Credit Union Act
Workpapers - Part216
- Part208
- Part206
- Part702
- Section 741.3
- Section 701.34
- Section 747.2002
- Section 747.2004
NCUA 5300 Call Report
Guidelines for Submission of an Application for a PCA Risk
Mitigation Credit
Guidelines for Evaluation of an Applications for a PCA Risk
Mitigation Credit
AIRES Net Worth Restoration Plan Checklist
NCUA Letter to Credit Unions: 01-CU-01 Prompt Corrective
Action (PCA) Implementation Information
Page 1712-8
WEIGHTED AVERAGE LIFE-APPENDIX 17A
The risk based net worth (RBNW) requirement rule specifies NCUA
will categorize all investments according to weighted-average life.
Weighted-average life may be used to measure all investment types.
For example, the weighted-average life of a bullet maturity instrument
is the time remaining to maturity. The following table is part of the call
report instructions. This table does provide for some exceptions
NCUA employs to calculate the RBNW requirement, e.g., corporate
credit union membership capital.
Investment Weighted average life for PCA

RBNW Calculation
Fixed-rate, non-callable, non- Period remaining to maturity date
amortizing debt obligations and
deposits (e.g., bullet maturity
instruments)
Fixed-rate amortizing debt obligations Weighted average-life according to
or deposits (investments with periodic industry standard calculations. (For
principal paydowns, e.g., mortgage example, industry-recognized
backed securities) information providers make available
weighted average-life calculations of
mortgage related securities based on
current prepayment estimates.)
Cash on deposit and cash equivalents Less than one (1) year
Mutual funds (registered investment (a) Mutual funds (registered investment
companies) and common trust companies) and common trust
investments (collective investment investments (collective investment
funds) funds): Use maximum weighted average
life as disclosed in prospectus or trust
instrument, but if not disclosed, report in
the 3-10 year range (as greater than 3
years, but less than or equal to 7 years
for the alternative component)
(b) Money market funds and Short-term
~~
investment funds (STIFs): 1 year or less
Callable fixed-rate debt obligations and Period remaining to maturity date
deposits ~~
Variable-rate debt obligations and Period remaining to next rate adjustment

deposits (regardless if investment date
amortizes)
Capital in mixed-ownership Greater than 1 year, but less than or
Government corporations and corporate equal to 3 years
credit unions
Investments in CUSOs Greater than 1 year, but less than or
equal to 3 years
Other equity securities Greater than 10 years
Page 17A-1
EXAMINER'S GUIDE
Sample Weighted-average life is defined as the weighted-average time to the

Weighted- return of a dollar of principal. It is calculated by the following:
Average Life
Calculation 0 Multiply each portion of principal received by the time at which it
is received (Column C = A * B, below).
0 Sum the totals of Time * Principal (Column C) and Principal

(Column B)
0 Divide the totals of Time * Principal (Column C) by total Principal

(Column B)
A B C
Time (Years) Principal Time*Principal
C=(A*B)
1 40 40
2 30 60
3 20 60
4 10 40
Total 100 200
Weighted-Average Life = Sum of (Time*Principal)=m = 2 Years

Total Principal 100
Weighted Average Life Calculation

Non-Amortizing Debt Obligation or Deposit I
A B C
Time (Years) Principal Time*Principal
I 1
I C=(A*B)
0 0
2 0 0
4 100 400
Total 100 400
Weighted-Average Life = Sum of (Time*Principal)=400 = 4 Years

Total Principal 100
Page 17A-2
NET WORTH RESTORATION PLAN (NWRP) SAMPLE
FORMAT - APPENDIX 17B
NWRP Credit Union Name:
Charter Number:
We, the Board of Directors of [CREDIT UNION N A M q submit for NCUA
approval the following Net Worth Restoration Plan (NWRP) and its
attachments.
The NWRP is filed because (choose the applicable provision):
Our net worth ratio declined as of the end of the [I"',2"d, r3 d, or 4Ih]
calendar quarter of [YEAR];
Our net worth ratio was recalculated as a result of the examination
report received on [DATE RECEIVED] by the officials;
We received notice we must submit a new NWRP within 30 days of
[DATE NOTICE RECEIVED];
We received written notice of reclassification on safety and
soundness grounds on [DATE NOTICE RECEIVED]; or
We received notice we failed to file a plan on [DATE NOTICE
RECEIVED].
Our net worth category is [CLASSIFICATIONCATEGORY as of

[EFFECTIVEDATE]. Our net worth totals $[DOLLARS] and quarter-end
assets total $[DOLLARS].Using the [CALCULATIONMETHOD], our total
assets are $[DOLLARS] and our net worth ratio is [PERCENT] percent,
calculated to two decimal places.
We understand our net worth ratio must be restored to six percent, or an

applicable risk-based net worth (RBNW) requirement, for the credit union to
become adequately capitalized. As of the date of our most recent call report,
we [DO NOT] have an applicable RBNW requirement [OF
PERCENT].
Page 17B-1
fld
EXAMINER’S GUIDE
This plan includes the seven components listed below that:
1. Specifies a quarterly timetable of steps to become adequately capitalized

(and must likely result in the credit union’s remaining adequately
capitalized for four consecutive calendar quarters beyond the end of the
term);
2. Establishes projected quarterly earnings transfers [AND REQUESTS A
REDUCTION IN THE REQUIREMENT TO TRANSFER TO THE
REGULAR RESERVE NOT LESS THAN 1/10 PERCENT OF TOTAL
ASSETS];
3. Sets forth how we will comply with the mandatory supervisory actions
we must take [AND ANY DISCRETIONARY SUPERVISORY ACTIONS
IMPOSED UPON US];
4. Identifies the types and levels of activities in which we will engage;
5. Specifies the steps we will take to correct (or notes the absence of)
unsafe or unsound practices or conditions;
6. Incorporates pro forma financial statements; and
7. Includes other information as required by NCUA.
Ouarterlv timetable of steps to become adequatelv capitalized

(§702.206(c)(l)(i))
The term of the plan will end at the earlier of either [END OF PLAN
D A T a or the expiration of four consecutive quarters of “adequate
capitalization.” We plan to become adequately capitalized by the end of
the term of this NWRP. If the plan terminates before achieving
“adequate capitalization,” a new plan will be required to reach that
objective. We understand we may not cancel our plan without NCUA
approval. We understand that once we are operating under this approved
NWRP, after prior written notice to, and approval by the Regional
Director, we may amend our plan to reflect a change in circumstance.
We understand that we must carry out the approved plan pending
approval of an amended plan.
During the term of our plan, we will take quarterly steps to improve our
net worth as follows:
Quarter for Plan of Action Responsible Person

Implementation Completion Date
I I I I
Based on these steps, we believe it is likely the credit union will remain
adequately capitalized for four consecutive calendar quarters beyond the
end of the term for the following reasons:
Page 17B-2
NWRP SAMPLE FORMAT - APPENDIX 17B
[OUR PRO FORMA FINANCIAL STATEMENTS (INCLUDED AS AN

ATTACHMENT UNDER COMPONENT SLX;BELOW) PROJECT OUR
NET WORTH TO BE AT LEAST SLX PERCENT FOR THAT TIME
PERIOD]
Proiected Ouarterlv Earnings Transfers ($702.206(c)(l)(ii))

We plan to increase net worth by at least l/lOth percent of total assets in
each quarter (except as noted below) and to transfer at least that amount
to the regular reserve according to the following schedule:
Schedule for Projected Quarterly Earnings Transfer
Projected
Opera- Net
Quarter Total Gross ting Net Reserve Net Worth
Ending Assets Income Expense Income Transfer Worth Ratio
I I I
I I I I
[WE PLAN TO TRANSFER LESS THAN I/ldhPERCENT OF TOTAL

ASSETS DURING QUARTERS AND REQUEST NCUA
APPROVAL. OUR CURRENTLY-OFFERED RATES ON SHARESARE
ATTACHED. WE HAVE SURVEYED THE FOLLOWING DEPOSITORY
INSTITUTIONS IN OUR RELEVANT UARKET AREA: [LIST]. THEIR
PREVAILING RATES ON ShYRES AND DEPOSITS ARE INCLUDED
IN THE ATTACHMENT. OUR ANALYSIS OF HOW THE DECREASE
IN THE REQUIREMENT WILL PERMIT US TO AVOID CURTAILING
OUR DIVIDENDS TO SUCHA DEGREE THAT WE WOULD SUFFER
A SIGNIFICANT REDEMPTION OF SHARES IS ALSO ATTACHED.
BY A VOIDING A SIGNIFICANT REDEMPTION IN SHARES, WE WILL
FURTHER THE PURPOSE OF PROMPT CORRECTIVE ACTION BY
RESTORING OUR NET WORTH RATIO BECAUSE WE WILL
(A VOID HIGHER COST OF BORROWED FUNDS, A VOID HA VING
TO SfiLL ILLIQUID ASSETS, OR ANY OTHER A VOIDANCE OF
LOSS). WE DO NOT PLAN TO OFFER RATES ON SHARES IN
EXCESS OF PREVAILING RATES ON SHARES AND DEPOSITS IN
OUR RELEVANT MRKET AREA.]
Mandatorv and Discretionarv Supervisorv Actions ($702.206(c)(l)(iii))

Our plan to comply with the mandatory supervisory actions (MSAs) and
discretionary supervisory actions (DSAs) imposed on us follows.
Page 17B-3
EXAMINER’S GUIDE
The four MSAs are:
0 Earnings transfer;
0 Submit net worth restoration plan;
0 Restrict increase in assets; and
0 Restrict member business loans.
Earnings transfer
The first MSA is addressed by the first two components of our plan, our
quarterly timetable of steps to become adequately capitalized and our
projected quarterly earnings transfers.
Submit net worth restorationplan

The second MSA is addressed by submission of this plan.
Restrict increase in assets

The third MSA is addressed in two time frames: ‘plan not approved”
and ‘plan approved.”
“Plan not upuroved.” We expect total assets to increase prior to plan

approval. Total assets will increase only by reason of the following three
exception categories:
0 First, total accounts receivable and accrued income on loans or

investments. This exception allows the accrual of income items,
increasing our net worth.
0 Second, cash and cash equivalents. This exception permits continued
receipt of member deposits and collection of cash payments of
interest income. We will increase investments only in the form of
cash equivalents.
Third, total loans outstanding, subject to a maximum equivalent to
the sum of total assets plus the quarter-end balance of unused
commitments to lend and unused lines of credit at the time the credit
union is classified undercapitalized or lower. We may continue to
make new loans in the normal course of business by reducing liquid
investment assets, and to honor unused commitments (such as
unused revolving loans or unused commitments for member business
loans) existing at the time we were classified undercapitalized or
lower. We will monitor total loans outstanding to ensure we do not
exceed the maximum.
We will not offer rates on shares in excess of prevailing rates on shares

and deposits in our relevant market area and will not open new branches
before our plan is approved. Before our plan is approved, we will
maintain records of:
0 The current offered rates on our shares; and

0 The prevailing rates on shares and deposits in our relevant market
area.
Page 17B-4
NWRP SAMPLE FORMAT - APPENDIX 17B
[WE WILL NOT A VAIL OURSEL VES OF THE EXCEPTIONS AND

WILL NOT BE SUBJECT TO LIMITATIONS ON RA TES AND
BRANCHING. WE UNDERSTAND THAT UNTIL OUR PLAN IS
APPROVED, WE CANNOT INCREASE TOTAL ASSETS UNDER ANY
CIRCUMSTANCES. 3
“Plan aDproved.” This M S A is addressed in the first two components of

our plan. We understand that our assets may only increase consistent
with the approved plan and we must implement our plan’s steps to
increase our net worth ratio.
Restrict member business loans (MBL)

We will not increase the total dollar amount of member business loans
(defined as loans outstanding and unused commitments to lend) as of the
preceding quarter-end, in the amount of $[DOLLARS].
[WE WERE GRANTED AN EXCEPTION TO THE MBL RESTRICTION

AS:
AN INSURED CREDIT UNION CHARTERED FOR THE PURPOSE
OF M K I N G , OR THAT HAS HISTORY OF PRMARILY M K I N G ,
MEMBER BUSINESS LOANS TO ITS MEMBERS, AS
DETEMINED BY THE NCUA BOARD; OR
A LOW-INCOME DESIGNATED CREDIT UNION; OR
0 A COMMUNITY DE VELOPMENT FINANCIAL INSTITUTION..]
We plan to extend new member business loans or new commitments for

member business loans. We will take the following steps to ensure we
will comply with the MBL restriction:
Steps to Comply With MBL Restriction
Quarter for Plan to Control Total Dollars of Responsible Person

Implementation MBL Completion Date
Ongoing
Discretionary supervisory actions

The NCUA has not imposed any discretionary supervisory actions on us.
Types and levels of activities (#702.206(c)(l)(iv))

We plan to continue to engage in the types and levels of activities
undertaken as of the date of our most recent examination, with the
exception that we plan to make the changes in the kinds of services
provided to our members noted under the first component of our plan
and other material changes as follows:
[DESCRIBE]
We are incorporating a copy of our business plan as an attachment.

[OPTIONAL]
Page 17B-5
EXAMINER'S GUIDE
Unsafe or unsound condition or practice (§702.206(c)(l)(v))

[THENCUA BOARD HAS NOTRECLASSIFIED US TO A LOWER NET
WORTH CATEGORY.]
or
[THENCUA BOARD HAS RECLASSIFIED US TO A LOWER NET
WORTH CATEGORY. WE WILL TAKE THE STEPS TO CORRECT THE
UNSAFE OR UNSOUND PRACTICES OR CONDITIONS AS
FOLLOWS]
or
[WE HAVE AN UNSAFE OR UNSOUND CONDITION OR PRACTICE
IDENTIFIED IN OUR EX4MINATION REPORT RECEIVED ON
[DATE RECEIVED] BY THE OFFICIALS. WE VOLUNTEERAS PART
OF THIS PLAN TO TAKE THE STEPS TO CORRECT THE PROBLEMS
AS FOLLOWS:]
Pro forma financial statements (§702.206(~)(2))

We are incorporating pro forma balance sheets and income statements,
including all off-balance sheet items, covering the next two years by
quarter [OPTIONAL:AND THE REMINDER OF THE TERM OF THE
PLAN BY YEAR, AND A SUMMARY OF THE ASSUMPTIONS, AS
ATACHMENTS. WE HAVE EUENDED THE PRO FORMA
ANALYSIS FOR ONE YEAR BEYOND THE TERM OF THE PLAN TO
DEMONSTRATE HOW WE PROJECT TO REMINADEQUATELY
CAPITALIZED.] Our pro forma financial statements are consistent with
our projected quarterly earnings transfers.
Other information as required by NCUA (§702.206(~)(3))

[OPTIONAL: WE FILE CALL REPORTS QUARTERLY AND THIS
DOCUMENT INCL UDES THE INFORMATION FOR THE QUARTER
ENDED [MARCH 31 OR SEPTEMBER 30, YEAR] SUPPORTING OUR
NET WORTH CLASSIFICATION CATEGORY.]
Submitted for the [CREDIT UNIONNAME]:
Chairman Date Chief Financial Officer Date

Board of Directors Board of Directors
Secretary Date
Board of Directors
Approved by the National Credit Union Administration:
Regional Director Date
For the [STATE SUPERVISORY AUTHORITY, if applicable]:
-
[TITLE] Date
Page 17B-6
Chapter 18
REGULATORY COMPLIANCE
TABLE OF CONTENTS
REGULATORY COMPLIANCE.................................................................................... 18-1

Associated Risks .................................................................................................. 18.1
Overview.............................................................................................................. 18-1
Examination Procedures ...................................................................................... 18-1
Charter and Bylaws .............................................................................................. 18-2
Security Program .................................................................................................. 18-2
Safeguarding Member Information.......................................................... 18-3
Margin Securities ................................................................................................. 18-4
Records Preservation ........................................................................................... 18-4
Call Reports ......................................................................................................... 18-4
Incidental Powers ................................................................................................. 18-5
Interest Rate Limitation ....................................................................................... 18-5
Appraisals ............................................................................................................ 18-5
Federal, State and Local Reporting Requirements............................................... 18-5
Regulation D ........................................................................................................ 18-8
Additional Information ........................................................................................ 18-8
References............................................................................................................ 18-8
APPENDIX 18A Bank Secrecy Act (BSA) ..................................................................... 18a-1
APPENDIX 18B Regulatory Flexibility Program (Reg Flex) ......................................... 18B-1
ATTACHMENT 18.1 - Money Laundering Red Flags ................................................... A1 8.1
7 bH.7.
1
Chapter 18
Examination 0 Determine whether the credit union assesses and mitigates risks
Objectives (e.g., through surety bond rider, internal audits, etc.)
Initiate corrective action to resolve deficiencies in practices,
policies, or procedures as well as violations of statute and
regulation
Associated 0 Compliance - the risk that failure to comply can result in penalties
Risks and lawsuits;
Strategic risk -the current and prospective risk to earnings or
implementation of decisions, or lack of responsiveness to industry
changes; and
0 Reputation risk - the risks that the credit union cannot meet
Overview NCUA’s Rules and Regulations along with other regulations that apply
to credit unions (e.g., regulations issued by the Federal Reserve Board)
form regulatory compliance. The amount of examination time spent on
a specific compliance area will depend on the amount of risk identified
in that area.
Examination Examiners should:

Procedures
0 Obtain and review the credit union’s regulatory compliance
program;
0 Review the system of internal controls to ensure on-going
compliance;
Ensure the credit union completed independent testing of the
program;
Page 18-1
EXAMINER'S GUIDE
Determine credit union designated an individual responsible for

coordinating and monitoring day-to-day compliance; and
0 Review the training provided to appropriate personnel.
Examiners should discuss emerging or unresolved deficiencies with

management and, if material deficiencies exist, they should include a
discussion in the examination report.
Charter and The credit union's charter sets forth the field of membership (i.e., who
Bylaws the credit union may accept as members.) The credit union must seek
approval from the regional director for any amendments to the charter
(name change, field of membership change, etc.). Examiners may
review the current field of membership and the credit union's
procedures to ensure that only the individuals within those groups
named in the charter are accepted as members.
Each credit union board adopts a set of bylaws, under which the credit
union operates. These may consist of a combination of pre-approved
bylaws, options, and standard amendments. Additionally, credit unions
may obtain approval for nonstandard bylaw amendments if they meet
certain criteria. Thus, the credit union has the responsibility to
maintain a current and complete set of its own bylaws.
The bylaws function as a contract between the credit union and its
members. Although credit unions must permit members to review the
credit union's bylaws on request, they need not provide members with
a copy of the bylaws.
Security Part 748 of the NCUA Rules and Regulations establishes minimum
Program security standards and procedures for credit unions. Examiners should
determine that the credit union (1) established an adequate security
program in accordance with the regulation, and (2) updates the
program to reflect operational changes.
Management must provide adequate safeguards to:

0 Protect the credit union from robberies, burglaries, larcenies, and
embezzlement;
0 Ensure security and confidentiality of member records;
Page 18-2
Assist in identification of persons who commit or attempt such

actions and crimes; and
Prevent destruction of vital records (as defined by Rules and
Regulations Part 749.)
The credit union's security program must include administrative,

technical, and physical safeguards appropriate to the size and
complexity of the institution and the nature and scope of its activities.
At a minimum, credit union management should design and implement
a comprehensive written security program to:
Identify key controls, systems, and procedures;

Assess internal and external threats;
Assign responsibilities;
Establish security procedures consistent with operating systems;
Provide periodic training of all employees;
Protect against destruction, loss, or damage of information, and
develop recovery procedures;
Ensure periodic testing of the security program;
Re-assess threats and the adequacy of controls;
Review monitoring systems and control procedures; and
Revise strategies.
Examiners may evaluate management's efforts to identifl, assess,

measure, mitigate, and monitor risks.
Safeguarding Appendix A of Part 748 of the NCUA Rules and Regulations provides
Member guidance standards for developing and implementing administrative,
Information technical, and physical safeguards to protect the security,
confidentiality, and integrity of member information.
Safeguarding member information requires a written comprehensive

program that includes administrative, technical, and physical
safeguards appropriate to the size and complexity of the credit union
and the nature and scope of its activities. The credit union should
design the program to:
Page 18-3
EXAMINER’S GUIDE
Ensure the security and confidentiality of member information;

0 Protect against anticipated threats or hazards to the security or
integrity of such information; and
Protect against unauthorized access to or use of such information
that could result in substantial harm or inconvenience to any
member.
Examiners may evaluate management’s efforts to identify, assess,

measure, mitigate, and monitor risks.
Margin When margin securities secure loans, federal credit unions must follow
Securit ies the provisions of Regulation U, Credit by Banks or Persons Other
Than Brokers or Dealers for the Purpose of Purchasing or Carrying
Margin Stocks, and the credit union members are subject to provisions
of Regulation X, Rules Governing Borrowers Who Obtain Securities
Credit, issued by the Federal Reserve Board. These regulations help
curb excessive credit in the securities market. Regulation U generally
applies to the lender, whereas Regulation X applies to the borrower.
Records Part 749 of NCUA Rules and Regulations (Vital Records Preservation)
Preservation permits credit unions to preserve records in electronic form in
compliance with the Electronic Signatures Global and National
Commerce Act. The rule also permits a credit union’s board to
determine which employee will assume responsibility for storing vital
records under the records preservation program, and incorporates an
appendix with suggested guidelines on retention periods for various
records.
Call Reports All federally insured credit unions must file quarterly call reports. It is
essential that each credit union files the call reports on time and
assumes responsibility for the material accuracy of the reports.
Examiners should address the credit union’s failure to submit an

accurate call report on a timely basis with the officials and, depending
on the circumstances and materiality, in the examination report.
Examiners may address repeat or material exceptions in the Document
of Resolution.
Page 18-4
Incidental The Incidental Powers regulation (Part 721, NCUA Rules and
Powers Regulations) authorizes federal credit unions to engage in activities
incidental to their business. The regulation provides examples of
permissible activities (such as certification services and finder
activities) and information on how to request a legal opinion on the
permissibility of activities not listed.
Interest Rate §(5)(A)(vi) of the FCUAct and §701.21(~)(7)of the NCUA Rules and
Limitat ion Regulations specifj that the rate of interest on a loan may not exceed
15 per centum per m u m on the unpaid balance (inclusive of all
finance charges) unless the NCUA Board establishes a higher ceiling.
The NCUA Rules and Regulations reflect the NCUA Board's
establishment of a higher rate, currently 18 percent. Charging a rate of
interest in excess of the statutory limitation is generally viewed as
usurious. Usury questions typically arise primarily in compensating
balances and recomputation for rebates.
Appraisals Part 722 of NCUA Rules and Regulations identifies the real estate-
related financial transactions at federally insured credit unions
requiring the services of a state-certified or state-licensed appraiser
(i.e., federally related transactions). Such appraisers must (1) have
demonstrated competency, (2) subject their professional conduct to
effective supervision, and (3) perform written appraisals in accordance
with the Uniform Standards of Professional Appraisal Practice
(USPAP). The FFIEC Appraisal Subcommittee monitors states'
licensure programs, and maintains a current list of licensed appraisers
for each state.
Federal, State Although not formally responsible for enforcing federal, state and local
and Local regulations, the examiner should bring any obvious violations to the
Reporting credit union's attention. The credit union could potentially incur
Requirements significant penalties and fines, which might harm the credit union's
financial condition. Following are regulations commonly present in the
operation of a credit union:
Form 1099 Reporting. The Interest and Dividend Compliance Act

requires credit unions to:
Page 18-5
EXAMINER'S GUIDE
- Contact members, in writing, requesting certification of

their social security numbers, under penalty of law;
- Initiate backup withholding on accounts with missing or
obviously incorrect social security numbers or if notified
by the IRS; and
- Report member dividends on paper 1099 forms; and report
member dividends to the IRS on magnetic media if the
credit union has 250 or more information returns, unless
the IRS granted the credit union an annual hardship
waiver.
Payroll reporting. If the credit union pays salaries, it must:
- Comply with the withholding provisions of the laws

relating to federal, state, and local income taxes, including
obtaining W-4 forms, distributing W-2 forms and filing
W-3 forms with the Social Security Administration and
state or local tax authorities;
- Report and pay, as required, federal, state and local
withholding, OASDI and Medicare; and
- Report and pay, as required, federal and state
unemployment compensation taxes.
0 Individual Retirement Accounts (IRA) Reporting. If the credit

union offers IRAs, it must:
- Prepare Form 5498 for distribution to the member and the IRS.
0 Mortgage Interest Reporting. If the credit union offers mortgage

loans, it must:
- Report annual interest of $600 or more paid by borrowers on

most real estate-secured loans on Form 1098 for distribution to
the IRS and the member.
Reporting for Discharges of Indebtedness. For reporting purposes,

the IRS considers indebtedness discharged on the occurrence of an
identifiable event indicating the debtor will never have to pay the
indebtedness. If appropriate, the credit union may report discharges
Page 18-6
of indebtedness if the indebtedness meets one of the following

tests:
A debt discharged in bankruptcy, but only if the debt was for

business or investment purposes;
A debt discharged by an agreement between the financial
institution and the member to accept an amount less than the
full amount of the debt;
A debt that the credit union decided not to pursue through
collection activity and discharges;
A debt on which a 36-month, non-payment testing period has
expired;
A debt extinguished because the statute of limitations the
debtor raised as an affirmative defense has expired;
A debt canceled or extinguished in receivership or foreclosure
in state or federal court;
A debt canceled or extinguished when the financial institution
elects foreclosure remedies; or
A debt canceled or extinguished, rendering it unenforceable in
probate.
(Note: A bookkeeping entry to charge off a loan does not by itself

qualify as an identifiable event.) Examiners should consider the
trigger points above in conjunction with the charge-off to
determine whether a discharge has occurred.
0 Additional reporting requirements include:
- The discharge must be $600 or more, no aggregation;

- Credit unions must provide copy of 1099-C to the member by
January 3 1 of the year following discharge; and
- Credit unions must provide original of 1099-C to the IRS by
2/28 of the year following discharge.
Credit unions must keep records of the return or the ability to

reconstruct the required data for four years from the required filing
date. For more information, review Section 6050.P of the Internal
Revenue Code.
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EXAMINER’S GUIDE
While examiners should bring obvious violations to the attention of

credit union management, examiners must take care to avoid
dispensing advice or guidance on how to interpret or resolve IRS
matters.
Regulation D Regulation D (Depository Institutions’ Reserve Requirements)

establishes the required amount a depository institution must reserve
based on the level of transaction accounts on deposit. Institutions must
maintain a certain level of reserves to assist the Federal Reserve Board
(FRB) in handling monetary policy.
Credit unions with net transaction accounts (primarily share drafts)

less than $5.5 million (as of April 2002 are exempt from reserving
requirements. The FRB annually updates the required reserve amount.
Credit unions have three options available for the retention of required
reserves, including:
0 Depositing required funds with FRB;

Holding required funds in vault cash; or
0 Holding required funds in pass through account.
Credit unions report directly to the Federal Reserve Bank in their

district. The FRB has the authority to assess penalties against credit
unions that do not hold adequate reserves.
Additional This chapter covers most regulatory compliance areas not addressed in
Information the section of the Examiner’s Guide to which they apply.
Appendix 18A addresses the Bank Secrecy Act (BSA) and Appendix
18B addresses RegFlex. Attachment 18-1 contains Money Laundering
Red Flags.
References 0 Regulation D of the Federal Reserve Board

0 FCU Act
- 5 107(5)(A)(vi)
Page 18-8
0 NCUA Rules and Regulations

- $721
- $722
- $748
- $749
IRS Rules
- Reporting of Wages
- Forgiveness of Debt
0 AIRES
- Consumer Compliance Questionnaire
Page 18-9
/@Yo &%i&
BANK SECRECY ACT (BSA) -APPENDIX 18A
Examination Determine the credit union’s level of compliance with the Bank
0bjectives Secrecy Act (BSA)
0 Ensure the credit union has adequate BSA policies, procedures,
and controls for each of the following:
- Verifying member identity
- Identifying reportable transactions
- Filing required reports
- Maintaining proper documentation
- Blocking and reporting transactions required by the Office of
Foreign Asset Control (OFAC)
- Complying with the U.S.A. Patriot Act (Patriot Act)
Risk Compliance - the current and prospective risk to earnings or

Categories capital arising from failure to comply with the BSA and the
resulting civil and criminal penalties;
Strategic - the current and prospective risk to earnings or capital
arising from inadequate policies, procedures and controls for BSA;
and
Reputation -the risk that negative publicity will adversely impact
earnings and capital.
Overview Failure to maintain strict compliance with the BSA can subject the
credit union to high levels of compliance (regulatory) risk, reputation
risk, financial losses, and other risks such as civil and criminal
penalties. At its worst, this deficiency can jeopardize national security.
Negative publicity may result in operational losses, a decline in net
worth, or the inability to attract members and competent staff.
Risk indicators include the following:
Inadequate due diligence by management when initiating new

programs or products;
Failure to appoint and train a compliance officer;
Inadequate policies or procedures;
Page MA-1
EXAMINER'S GUIDE
Inadequate audit;
Inability of data processing system to generate BSA reports;
Inadequate review by management of BSA reports from data
processing system;
Lack of adequate management oversight;
Inadequate training; and
High staff turnover.
While a credit union may not knowingly risk its reputation for a
member engaged in criminal activity, it must take steps to guard
against the possibility of permitting or facilitating criminal activity.
Bank Secrecy The BSA includes several related acts such as the Anti-Drug Abuse
Act Act, the Money Laundering and Control Act, the Currency and Foreign
Transactions Act and the USA Patriot Act, all of which were enacted
by Congress. The BSA requires maintenance of certain types of
records and reports useful to criminal, tax, or regulatory investigations.
The Department of Treasury issued the implementing regulations in 3 1
CFR 103. 5748.2 of the NCUA Rules and Regulations requires that
credit unions establish and maintain procedures to assure and monitor
compliance with the BSA and the implementing regulations.
Specific provisions of the BSA were designed to:
Prevent members from using financial service providers as

intermediaries to accomplish or hide the transfer or deposit of
monies derived from criminal activity;
Prevent, detect, and prosecute terrorism and international money
laundering; and
0 Provide a paper trail of activities.
Therefore, credit unions must file certain currency and monetary

instrument reports and maintain certain records, including identifying
and recording cash purchases of certain monetary instruments. Credit
unions must also understand the following constitutes criminal
offenses:
Knowingly helping to launder money from criminal activity;
Page18A-2
BANK SECRECY ACT (BSA) - APPENDIX 18A
Knowingly engaging in (including being “willfully blind”) a

transaction of more than $10,000 that involves property from
criminal activity; and
0 Structuring transactions to avoid BSA reporting.
The Department of Treasury may assess civil and criminal penalties on

any domestic credit union and upon any director, officer, or employee
for willful violation of the BSA. Penalties can include both fines and
prison terms. Therefore, due diligence regarding BSA requires credit
union officials to train their employees, identify members using
appropriate documentation, understand members and members’
businesses, and institute systems and procedures to distinguish
between routine transactions and those that may indicate suspicious
activity. The Treasury may also assess fines for negligence.
Enforcement NCUA must, by law, determine during each examination whether the
credit union:
0 Conducts money-laundering schemes;

0 Complies with technical reporting and record keeping requirements
of the BSA; and
0 Adopted policies and implemented procedures to detect, deter, and
report unusual or suspicious activities related to money laundering
(31 CFR 103.46 (b)(5)).
Therefore, violations of the BSA necessitate immediate corrective

action. Failure of a credit union to take immediate and effective
corrective action may warrant administrative action. Examiners must
document BSA violations and compliance deficiencies on the
Consumer Compliance Violations Form.
Member Due The objectives of a member due diligence program include:

Diligence
0 Protecting the reputation of the credit union;
0 Facilitating the credit union’s compliance with BSA requirements;
0 Enforcing OFAC and Patriot Act regulations and enhancing
national security; and
Page 18A-3
EXAMINER’S GUIDE
0 Protecting the credit union from becoming a vehicle for, or victim

of, illegal activities by the member.
Credit Union’s A credit union’s responsibility includes knowing the identity of each
member and assuring the member’s account is not used for illegal
purposes. The credit union should have policies and procedures for
verifying the identity of its members and determining consistency of
account activity.
The credit union’s due diligence policy should reflect the following:
0 Size and complexity of the credit union;

0 Nature and extent of the services offered;
Level of risk; and
Documentation requirements.
The credit union’s documentation requirements and due diligence

procedures should include, at a minimum:
0 Documentation requirements for verifying the identity of the

member;
Documenting the source of the member’s funds, if deposits exist
that include other than normal routine transactions;
0 Determining the member’s normal and expected transactions;
0 Identifying unusual transactions, or activities disproportionate to
the member’s known business; and
0 Determining criteria for when the credit union should report a
transaction as a suspicious activity on a Suspicious Activity Report
(SAR.)
Identifying a Member identification procedures should include:

Member
Obtaining, examining, verifying, and recording primary
identification, such as the following:
PagelSA-4
- Drivers License;
- Passport;
- Government ID; or
- Alien Registration Card.
0 Obtaining and recording primary information such as:
- Full name with street or postal address;

- Social Security number, taxpayer ID number;
- Date of birth;
- Home and work phone numbers; and
- Bank or other credit union references.
0 Obtaining, examining, verifying, and recording secondary

identification, for example:
- Credit card;
- Employer card;
- Unioncard;
- Voter registration card; or
- SchoolID.
0 Verifying as much of the information as possible, including:
Physical observation of the address (drive by to see if the

address is legitimate);
Call backs (validate the phone number by calling it);
Check with a third party (call references given);
Use of a verification service;
Use of a reverse directory to verify the phone number and
address match;
Check the telephone book;
Contact previous employer; and
Obtain a credit report.
0 Determining whether the member is on any list of known or

suspected terrorists provided by any federal government agency,
including:
Page MA-5
EXAMINER'S GUIDE
- 0FAC;and
- the Control List (FBI-maintained).
Identification When a member opens a business account at a credit union (after staff
Procedures fora has determined membership eligibility), the credit union must ascertain
Business the person's authorization to open the account by establishing the true
Account
identity of the person and the principals of the business using the
following procedures:
0 Obtaining, examining, verifying, and recording evidence of the

legal status, for example:
- Incorporation documents;
- Partnership agreements;
- Association documents;
- Business licenses; and
- Corporate resolutions.
0 Obtaining and verifying information about the business, for

example:
- Financial statements of the business;

- A description of the business; and
- A description of the trade area.
0 Obtaining, verifylng and recording identification of principals the

same as for natural person members.
0 Verifying as much of the information as possible. Some ways

include:
Physical observation of the address;

Callbacks;
Check with a third party;
Verification service;
Reverse directories;
Telephone book;
Contact previous financial institution;
Credit reports;
Pagel8A-6
BANK SECRECY ACT (BSA)-APPENDIX 18A
- Dun and Bradstreet reports; and

- Lexis/Nexis searches.
The credit union should remain alert to inconsistencies between the

account activity and the member’s business.
Reporting Credit unions must file the following as required by provisions of the
Requirements BSA reporting requirements:
Currency and Transaction Report (CTR); and

0 Suspicious Activity Report (SAR.)
Currency and Credit unions must file a CTR (Form 4789) with the IRS Detroit
Transaction Computing Center (1) each time a member makes a deposit,
Report (CTR) withdrawal, exchange, or other transfer of more than $10,000 in
currency, or currency instruments such as bank checks or drafts, money
orders, or travelers checks; or (2) when a member exceeds $10,000 in
one cash transaction or $10,000 in multiple cash transactions in one
business day. (Currency is defined as U.S. or foreign coin or currency,
but does not include bank checks or other negotiable instruments.)
Transactions spread over a number of days may constitute a reportable
transaction if the member structured the deposit to evade reporting
requirements. (Exemptions exist for transactions between financial
institutions and with legitimate retail businesses.)
Structuring Transaction structuring attempts to circumvent the reporting

requirements of BSA. Structuring exists when a person, whether acting
alone or with somebody, conducts, or attempts to conduct, a
transaction for the purpose of evading the BSA reporting requirements.
Notice that the individual does not have to succeed in conducting a
transaction for a violation to have occurred, nor do they escape
criminal liability by merely assisting someone attempting to structure a
transaction.
Due to the possibility of structuring, a credit union must treat multiple

currency transactions as a single transaction if it has knowledge that
the transactions were made by, or on behalf of, any person and resulted
Page MA-7
EXAMINER’S GUIDE
in either cash in or cash out totaling more than $10,000 during any one
business day. Credit unions should file a CTR with the IRS Data
Center in Detroit, Michigan, within 15 days after the transaction and
must retain copies of the form for five years.
Credit unions may obtain Form 4789 by calling the IRS Forms
Distribution Center at 1-800-829-3676, accessing the IRS web site at
http://www.irs.treas.Fzov/forms pubs/forms.html, or the U.S.
Department of the Treasury’s Financial Crimes Enforcement Network
(FinCEN) web site at http ://www.treas .aov/fincen/forms.html .
Exemptions Certain account holders receive an exemption from the requirement to

from CTR file a CTR. The five mandatory exemptions include:
Reporting
Banks or other financial institution, to the extent of their domestic
operations;
A government department or agency, including federal, state and
local governments;
Any entity established under federal, state, or local government
that exercises governmental authority (i.e., has the power of
taxation, eminent domain, or police authority);
Any entity listed on the New York Stock Exchange, the American
Stock Exchange, or whose common stock has been designated as a
NASDAQ National Market Security listed on the NASDAQ Stock
Market (except those listed under the “NASDAQ Small-Cap
issue); and
0 Any subsidiary of a listed entity organized under federal or state
law where the listed entity owns at least 5 1 percent of its stock or
equity interest.
Following are characteristics of a “non-listed business” that may also

receive an exemption:
0 Incorporated or organized under the laws of the United States or a

state, or is registered and eligible to do business within the United
States;
0 Maintained a transaction account at the credit union for at least 12
months; and
Page18A-8
Frequently engages in transactions in currency with the credit

union in excess of $10,000, or only withdraws more than $10,000
in cash to pay its United States employees in currency.
The credit union must designate each exempt person or entity by filing
a Designation of Exempt Person Treasury Form (TD F 90-22.53) with
the Department of Treasury within 30 days of the date of the first
reportable transaction. (The credit union need not file an exemption for
transactions with any of the twelve Federal Reserve Banks.)
At least once each year, the credit union must review, verify, and
document the information supporting each designation of a “non-
listed” or “payroll customer” exempt person or entity and the
application of each account of an exempt person or entity. Further, the
credit union must renew the exempt status of the “non-listed” or
“payroll customer” exempt members by filing a Designation of
Exempt Person Treasury Form” (TD F 90-22.53) with FinCEN by
March 15 of the second calendar year following the original exemption
and biennially thereafter. The renewal must include:
A statement that the credit union has applied its system of

monitoring transactions for suspicious activity to the exempt
persons accounts at least annually; and
Any information about a change in control of the exempt person or
entity.
The credit union may not treat any of the following businesses as a
non-listed business and may not exempt those with the following
characteristics:
0 Serve as a financial institution or agent of financial institutions of

any type, such as check cashing or currency changers;
Purchase or sell motor vehicles of any kind, vessels, aircraft, farm
equipment, or mobile homes;
0 Practice of law, accountancy, or medicine;
0 Auction goods;
0 Charter or operate ships, buses, or aircrafi;
0 Gaming of any kind (other than licensed pari-mutuel betting at race
tracks);
Investment advisory or investment banking services;
Page 18A-9
EXAMINER’S GUIDE
Real estate brokerage;

Pawn brokerage;
0 Title insurance and real estate closing;
Trade union activities; and
Any other activity that may be specified by FinCEN.
Credit unions may treat a business that engages in multiple business

activities as a “non-listed business” as long as it receives no more than
50 percent of its gross income from one or more of the ineligible
business activities listed above.
Exemptible The credit union may grant exemptions to a member for all share and
Accounts money market accounts held by the member for the commercial
enterprise as long as the enterprise qualifies for the exemption.
If the credit union determines that a member qualifies for a CTR

exemption, the exemption includes all large currency transactions as
long as they are normal for the type of business conducted by the
exempt person or entity. The credit union may not exempt a
transaction carried out by an exempt person acting as an agent for
another person who owns the funds, but who does not have an
exemption.
Liability Limits Failure to file a CTR with respect to transactions in currency by an

exempt person or entity will not subject the credit union to penalty
unless the credit union does the following:
Knowingly files false or incomplete information with respect to the

transaction or the member engaging in the transaction; or
0 Has reason to believe (1) the member does not meet the criteria for
the exemption or (2) the person performing the transaction was not
an exempt person.
Suspicious The credit union must use the SAR to report all known or suspected
Activity criminal offenses, including transactions involving possible money
Report (SAR) laundering or violations of the BSA. Generally, a credit union should
file a SAR within 30 days fiom the initial detection of the suspicious
Page18A-10
activity. If it cannot identify a suspect, the time period for filing a SAR
extends to 60 days. In situations involving violations of law requiring
immediate attention, the credit union should immediately notify, by
telephone, appropriate law enforcement and supervisory authorities, in
addition to filing a SAR.
A credit union must file a SAR with the IRS Detroit Computing Center
(Financial Crimes Enforcement Network) following the discovery of
known or suspected federal criminal violations, or pattern of criminal
violations conducted by, at, or through the credit union with the
following characteristics:
0 Insider abuse involving any amount. The credit union must have a
substantial basis for identifying one of its directors, officers,
employees or agents as having committed or aided in the
commission of a criminal act regardless of the amount involved;
0 Violations aggregating $5,000 or more where a suspect can be
identified. The credit union must have a substantial basis for
identifying a possible suspect or group of suspects; and
0 Violations aggregating $25,000 or more regardless of a potential
suspect. The credit union has no basis for identifying a possible
suspect or group of suspects.
In addition, a credit union must file a SAR for any transaction

conducted or attempted by, at, or through the credit union and
aggregating $5,000 or more, if the credit union knows, suspects, or has
reason to suspect that the transaction:
0 May involve potential money laundering;

0 Involves funds derived from illegal activities or is intended or
conducted to hide or disguise finds or assets derived from illegal
activities;
0 Is designed to evade the BSA or its implementing regulations;
0 Has no business or apparent lawful purpose, or is not the sort in
which the member would normally be expected to engage, and the
credit union has no reasonable explanation for the transaction.
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EXAMINER'S GUIDE
The credit union must file a SAR for the above activities at the stated
thresholds, but may voluntarily file for transactions below these
thresholds. It must not notify any person involved in the transaction
that the transaction has been reported and must not make such
disclosure even under subpoena.
Credit unions must also file a SAR on suspicious activity even when a
portion of the activity occurs outside of the United States or the funds
involved in the activity originated from outside the United States.
Although federal law does not require foreign-located operations of
U.S. credit unions to file a SAR, a foreign branch may wish to file a
SAR with regard to suspicious activity that occurs outside the United
States if that activity is so egregious that it has the potential to cause
harm to the entire organization. (Foreign-located operations of U.S.
credit unions that identify suspicious activity should report such
activity consistent with local reporting requirements in the foreign
jurisdiction where the operation is located.)
Credit Unions Credit unions should ensure the accuracy and completeness of any
Completing SAR it decides to file. The SAR should describe the following:
SARs
The suspect, including the individual's occupation or nature of the
suspect's business and known relationships;
The instruments or mechanisms used;
All the accounts involved in the suspicious activity, including

account activity in multiple branches;
The dates the suspicious activity occurred, and was noticed, and
the duration of the activity;
Dollar amount involved; and
The reasons the credit union suspects the activity. Describe the
transaction or activity, why the activity or transaction is unusual for
the member, whether a pattern of ongoing activity exists, and the
person to contact for more information.
Pagel8A-12
The credit union should provide requested information for each section
of the form. It should not use terms such as “same as above” or “not
applicable.” If the credit union needs to repeat pertinent information, it
should enter the information again. If it does not know certain
information, it should leave the section blank.
The credit union should not send supporting documentation with the
SAR; however, under the SAR regulations, financial institutions filing
a SAR must retain all “supporting documentation”related to the
reported activity for five years, and disclose supporting documentation
to appropriate law enforcement agencies or FinCEN upon request.
FinCEN’s website has SAR forms, guidance, and software available at

http://www.treas.gov/fincen/forms.html,or by hyperlink from NCUA’s
web site www.ncua.gov.
Money Objectives of the BSA include detecting and deterring money

Laundering laundering, providing a paper trail of suspicious transactions, and
reducing the profit of the perpetrators. Money laundering constitutes a
federal crime designed to conceal the proceeds of another criminal
activity, such as drug dealing, arms trafficking, credit card swindles, or
terrorist activities.
Money laundering has the following stages:
0 Getting illicit funds (cash or cash equivalent) into or out of a U.S.

financial institution (placement);
0 Commingling the illicit funds with other funds to confuse their
origins (layering); and
0 Reintroducing the funds into the economy (integration).
Follow Up on If conduct continues for which a credit union has filed a SAR, the
Suspicious credit union should report continuing suspicious activity with a SAR at
Activity least every 90 days even if a law enforcement agency has declined to
investigate or the credit union has knowledge that an investigation has
begun.
Page 18A-13
EXAMINER'S GUIDE
The filing of SARs on continuing suspicious activity provides useful

information to law enforcement and supervisory authorities. Moreover,
the information contained in a SAR that one law enforcement agency
has declined to investigate may interest other law enforcement
agencies, as well as supervisory agencies. Should activity of concern
continue over a period of time, the credit union should share such
information with law enforcement and financial regulators.
By filing a report on continuing suspicious activity at least every 90

days, the credit union will notify law enforcement of the continuing
nature of the activity, as well as provide a reminder that it must
continue to review the suspicious activity to determine other
appropriate actions.
Dealing With Since a credit union member has a fundamental right to maintain a
Persons share account and participate in elections, the credit union cannot deny
Reported on someone credit union membership because it has identified suspicious
SAR
activity. However, the credit union may wish to consider limiting
access to certain services. To do so, the credit union must have
established written policies and have notified its members of the
policies in advance. The credit union should not consider the mere
filing of a SAR as the basis for limiting services.
Similarly, the credit union may find it necessary to consider

reassigning or terminating the services of an employee who is the
subject of a SAR. The credit union should seek advice fiom counsel in
these situations.
The credit union may not, by law, notify any person involved in an
activity being reported on a SAR that the credit union has reported the
activity, or that it has filed a SAR (3 1 U.S.C. 53 18(g)(2)). However,
this prohibition does not preclude a disclosure in an appropriate
manner of the facts that serve as the basis of the SAR, so long as the
disclosure is not made in a way that indicates or implies that the credit
union has filed a SAR, or that the SAR includes that information.
Page18A-14
Summary of CTR The implementing regulations of the BSA require a credit union to file
and SAR a CTR whenever a currency transaction exceeds $10,000. If the
Reporting currency transaction exceeds $10,000 and is suspicious, the credit
union must file both a CTR and SAR. If a currency transaction equals
or is below $10,000 and is suspicious, the credit union should only file
a SAR.
Other Reporting Credit unions must also adhere to the following other reporting
Requirements requirements if applicable:
Foreign Bank and Financial Accounts Report (FBAR), IRS Form

TD F 90-22.1. A credit union must file a FBAR if it has a financial
interest in, or signature authority over one or more financial
accounts in foreign countries and the aggregate value exceeds
$10,000;
Reports of certain transactions with designated foreign financial
agencies upon specific notice required by the Secretary of
Treasury; and
0 Special requirements imposed by the Secretary of Treasury for a
limited period of time whereby credit unions in a certain
geographic area must report currency transactions in amounts
below $10,000.
In addition, an individual must file Form 4790, Report of International

Transportation of Currency or Monetary Instrument (CMIR), each time
a person sends or receives more than $10,000 in currency or monetary
instruments into or out of the United States. The person (not the credit
union) who physically transports, mails, or ships, or causes the
shipment, transportation, or mailing of currency and/or monetary
instruments into or out of the U.S must file the report within 30 days of
the transaction.
BSA Record- Credit unions must retain all records required by the BSA for five
keeping years, and must provide access to the records upon request within a
Requirements reasonable period of time. At a minimum, credit unions must retain the
records as original, microfilm, or other copy or reproduction, both
front and back.
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EXAMINER’S GUIDE
A credit union must verify and record information relating to the

identity of the purchaser of monetary instruments, such as bank checks
or drafts, money orders, or travelers checks, in exchange for currency
in amounts between $3,000 and $10,000. (Credit unions must report
amounts over $10,000 on a CTR.) The credit union must maintain the
data in monthly chronological logs, which it must retain for five years.
The information must include:
The purchaser’s name;

The purchaser’s account number;
Date of purchase;
Branch location of purchase;
Types of instruments purchased;
Serial number of instrument purchased;
Dollar amount of each instrument purchased; and
Verification of purchaser’s identity, including the type of verifying
information used.
A credit union must also maintain the following:
A record of each loan that exceeds $10,000 (except those secured

by real estate), which must contain the borrower’s name and
address, the amount, purpose or nature, and date of the loan;
A record of each advice, request, or instruction received or given
regarding any transaction resulting in or intending to result in the
transfer of currency and other monetary instruments, funds, checks,
investment securities, or credit, of more than $10,000 to or from
any person, account or place outside the United States;
A record of any report required by the Department of Treasury’s
special order concerning the transfer of United States coins or
currency in a geographic area;
Member identification information and payment data related to the
sender and the recipient of each incoming or outgoing wire transfer
of $3,000 or more. (31 CFR 103.33 (e));
Member identification information obtained to comply with the
Patriot Act for five ( 5 ) years after the account has been closed;
Social security number or taxpayer identification number (TIN) for
each share account and share certificate account;
Either the original or a copy of each of the following:
Pagel8A-16
The signature card granting signature authority over each share

account, including the information used in verifying the
signer’s identifl, such as a driver’s license number;
Each statement, ledger card or other record for each share
account, showing each transaction for that account;
Each check, clean draft, or money order drawn on the credit
union, or issued and payable by the credit union unless the
amount is less than $100, drawn on an account that averages at
least 100 checks a month, and written for employee benefits or
dividends. (31 CFR 103.34 (b)(3));
Each item in excess of $100 comprising a debit to a member’s
deposit account not otherwise exempted;
Each item, including checks, drafts, or transfers of credit, of
more than $10,000 remitted or transferred to a person, account,
or place outside the United States;
Each record of remittance or transfer of funds, currency, other
monetary instruments, checks, investment securities, or credit,
of more than $10,000 to a person, place, or account outside the
United States;
Each check or draft in an amount in excess of $10,000 drawn
on or issued by a foreign bank which the credit union has paid
or presented to a nonbank drawee for payment;
Each item, including checks, drafts or transfers of credit, of
more than $10,000 received directly and not through a
domestic financial institution, by letter, wire, or any other
means from a bank, broker, or dealer in foreign exchange
outside the United States;
A record of each receipt of currency, other monetary
instruments, investment securities or checks, and of each
transfer of funds or credit, of more than $10,000 received on
any one occasion directly from a bank, broker, or dealer in
foreign exchange outside the United States;
Records prepared or received by the credit union in the
ordinary course of business and needed to reconstruct a share
draft account and to trace a check or share draft in excess of
$100 deposited in such account through its processing system
or to supply a description of a deposited check or share draft in
excess of $100 (this applies to demand deposits only);
A record containing the name, address, and taxpayer
identification number, if available, of any person presenting a
Page 18A-17
EXAMINER'S GUIDE
certificate of deposit for payment, as well as a description of

the instrument, and the date of the transaction; and
- Each deposit slip or credit ticket reflecting a transaction in
excess of $100 or the equivalent record for direct deposit or
other wire transfer deposit transactions. The slip or ticket shall
record the amount of any currency involved.
Wire Credit unions must obtain and retain complete information about the
Transfers parties to a funds transfer of $3,000 or more. The text of every
payment order must include the following:
0 Name and address of the originator;

0 Amount of the payment order;
0 Execution date of the payment order;
0 Payment instructions received from the originator with the
payment order;
0 Identity of the beneficiary's bank; and
0 As many of the following items as the credit union receives with
the payment order:
- Name and address of the beneficiary;

- Account number of the beneficiary; and
- Any other specific identifier of the beneficiary.
Office of The Office of Foreign Asset Control, within the Department of

Foreign Treasury administers a series of laws that impose economic sanctions
Assets against hostile targeted foreign countries and their agents, terrorism
ControI sponsoring organizations, international narcotics traffickers and
(OFAC) specially designated nationals. The economic sanctions further U.S.
foreign policy and national security. The OFAC website,
www.treas.gov/ofac, contains specific OFAC laws and provisions.
NCUA is responsible for determining that credit unions comply with
the OFAC regulations.
Part 748 of NCUA's Rules and Regulations requires a credit union to

have a Bank Secrecy Act compliance program and procedures.
Although no specific requirement exists for a policy on compliance
with OFAC regulations, the credit union must comply with the
Pagel8A-18
regulations. Credit unions may include these requirements within the

Bank Secrecy Act compliance policy.
Definitions Blocking, or freezing: a form of controlling assets under U.S. jurisdiction. While
title to blocked property remains with the designated country or national, OFAC may
prohibit the exercise of the powers and privileges normally associated with
ownership without its authorization. Blocking immediately imposes an across-the-
board prohibition against transfers or transactions of any kind without regard to the
property.
Property: anything of value. Practically everything that banks do every day involves
property within the meaning of the regulation. Examples include: money, checks,
drafts, evidences of title, obligations, debts and anything else real, personal, tangible
or intangible. Property also covers direct, indirect, present, hture and contingent
interests.
Credit Union Credit unions must block or "freeze" the assets, funds transfers, and all
Requirements transactions of all designated countries and their agents, specially
designated terrorists, foreign terrorist organizations, specially
designated narcotics traffickers and blocked persons. In addition,
OFAC may require the credit union to reject or return incoming
transfers from prohibited sources.
Credit unions can obtain a listing of prohibited sources by checking the

OFAC website. The credit union should frequently update the list of
prohibited sources by checking the OFAC website and documenting
their check. If a credit union does not have website access, the credit
union's may call OFAC at 1-800-540-6322.
The credit union should compare new accounts with the prohibited
listing. The credit union may open the account, but should immediately
block the funds so that account owners can make no withdrawals. In
some cases, it is appropriate to reject the funds, i.e., the OFAC website
contains the proper course of action for each law.
Credit unions must check the names of all parties to a transaction,

including:
0 Beneficiaries;
0 Collateral Owners;
0 GuarantorsKosigners;
Page 18A-19
EXAMINER'S GUIDE
Receiving Parties; and

Sending Parties.
The credit union must review every type of transaction for compliance
without limitation, including the following:
Share accounts of all types;

Loans, credit cards and lines of credit;
Letters of credit;
Safety deposit boxes;
Wire and ACH transfers;
Currency exchanges;
Depositing and cashing checks;
Purchase of money orders or traveler's checks;
Loan payments;
Guarantors and collateral owners; and
Trust accounts.
Large and sophisticated credit unions may have special software which
can interdict prohibited transactions. If the credit union identified any
accounts, transactions or property, which match the prohibited listing,
the credit union must immediately block or reject the assets as
required.
OFAC Reporting The credit union must report all blockings and or rejections to the
Requirements Office of Foreign Asset Control within 10 days of the occurrence. For
blocked property, the credit union must report the following
information:
Owner or account party;

The property or amount of funds;
The property location;
Any existing or new account number or similar reference necessary
to identify the property;
Actual or estimated value of the property;
The date it was blocked;
A photocopy of the payment or transfer instructions;
The individual or entity subject to blocking;
The name and address of the holder; and
Page18A-20
0 The name and phone number of the contact person at the credit
union who can provide compliance information.
Reports on rejected items must include:
0 The name and address of the transferee credit union;

0 The date and amount of the transfer;
0 A photocopy of the payment or transfer instructions received;
0 The basis for the rejection; and
0 The name and telephone number of a contact person at the
transferee credit union who can provide compliance information.
There is no designated form for filing reports of blocked or rejected

items. Credit unions should fax reports on blockings or rejected items
with the above information to the OFAC Compliance Division at (202)
622-2426.
The credit union must also file a comprehensive report on blocked

property held as of June 30, by September 30, each year. Credit union
must use Form TDF 90-22.50, which is available on the OFAC home
page.
Record OFAC requires the credit union retain all reports of blockings or
Retention and rejected items and the related records for five years.
Penalties
Penalties vary depending on the specific law, which is violated.
However, OFAC has the authority to impose corporate or personal
penalties up to $1 million and 12 years in jail, civil penalties up to
$250,000 per incident, and forfeiture of funds involved in the
violation. Criminal penalties may also apply.
U.S.A. Patriot The U.S.A. Patriot Act contains strong measures to prevent, detect,
Act and prosecute terrorism and international money laundering. The U S .
Department of the Treasury issued rules setting forth minimum
standards for member identification upon account opening. The rules
are part of BSA. Among other items, the rules require credit unions to:
0 Verifl members’ identity;
Page 18A-21
EXAMINER’S GUIDE
Maintain identity documentation records;

0 Compare member names with lists of known or suspected
terrorists; and
0 Provide adequate notice to members.
Identity Credit unions must develop procedures based on the assessment of the
Verification risks presented by the various types of accounts (regular shares, share
Procedures drafts, business, etc) and the methods used to open an account (in
person, by mail, etc). The credit union must reasonably believe they
know the true identity of the member.
For non-U.S. citizens identity verification becomes more difficult. The

credit union may use various methods to verify identity. The credit
union may accept any government-issued document evidencing
nationality or residence and bearing a photo or similar safeguard.
Businesses may provide registered articles of incorporation,
government-issued business licenses, partnership agreements, etc. to
verify identity. If credit unions use other methods to verify identity,
their procedures must require they perform the verification within a
reasonable period after the account is opened.
If, according to the credit union’s assessment risk is limited, actual

documents need not always be obtained when verifying identity. The
credit union may choose to monitor the specific account if the member
does not provide physical documentation or is in the process of
obtaining verification documentation.
Maintenance Of The credit union must maintain all information obtained to document
Verification the member’s identity for five (5) years after the account has been
Information closed.
Comparison with The credit union’s procedures must specify that it will determine
Government whether the member is on any list of known or suspected terrorists
Lists provided by any federal government agency. This would include
OFAC and the Control List (maintained by the FBI).
Page18A-22
BANK SECRECY ACT (BSA)-APPENDIX 18A
Notification to The credit union must notify members that steps will be taken to verify
Members the identity of all members. This requires the credit union to post a
general notice in the lobby, on their website, or by some other general
method. It does not require the credit union to send individual paper
notices to every member.
Part 748 of the NCUA Rules and Regulations covers the Anti-Money
Laundering Program provisions of the Patriot Act.
FinCEN issued rules implementing the cooperative efforts to deter

money-laundering provisions of the Patriot Act. These rules:
Encourage information sharing among financial institutions and

federal government law enforcement agencies to identifl, prevent,
and deter the financing of terrorist activity;
Require credit unions search their records to determine if they have
accounts for, or have engaged in transactions with, specific
individuals, entities or organizations named by FinCEN in a
request;
Require the designation of a person to receive such requests from
FinCEN; and
Permit information sharing between financial institutions upon
prior notification of FinCEN of its intent to share information.
FinCEN FinCEN collects data on potential violations of federal criminal law as

well as suspicious transactions related to money laundering offenses
and violations of the BSA. Its primary tool in administering the BSA is
a uniform interagency SAR used by all financial institutions.
Referrals to In some instances, examiner should recommend referral of BSA

FinCEN violations for further action. Examiners should forward BSA referrals
with appropriate comments through the supervisory examiner to their
regional director. In cases involving suspected ongoing criminal
activity, the examiner should immediately contact the supervisory
examiner, who will give the examiner further instructions after
consulting with regional management. The Office of Examination and
Insurance consults with the Office of General Counsel before making
Page 18A-23
EXAMINER'S GUIDE
final decisions on referrals to FinCEN. Examiners should consider the

following in determining whether to recommend referral:
Suspected instances of money laundering or structuring of

transactions to avoid reporting;
Evidence the credit union or an official committed a flagrant
violation, demonstrated bad faith, attempted to conceal the
violation, or committed the violation with disregard for the law or
the consequences to the institution;
Failure of the board or an individual to cooperate with NCUA to
affect an early resolution and correction of a violation;
Continuation, frequency, or recurrence of a violation, especially
instances where NCUA, Treasury, FinCEN, IRS, Securities and
Exchange Commission (SEC), Customs Service, or the credit
union's independent reviewer advised the credit union of the
violation;
Evidence that insiders, participants in the currency transaction, or
their associates benefited directly or indirectly as a result of a
violation;
Evidence that a violation may have facilitated or concealed illegal
activity by the credit union, its employees, its members, or others;
Absence of a compliance program or severe inadequacies in the
compliance program;
Failure by the credit union or individuals to adhere to the
requirements of a compliance program; and
Indication of false record keeping entries.
The following examples include situations that warrant referral:
Intentional or unintentional failure to file a CTR or CMIR as a

pattern or practice at a certain location or for one or more specific
members or accounts. This includes failure to report aggregated
transactions when the credit union has a system that identifies
multiple related transactions occurring on the same day;
Failure to maintain a centralized list of members or accounts
exempted fiom the reporting requirements;
Failure to obtain and maintain the exemption certification
statement for exemptions granted after October 27, 1986;
Page18A-24
0 Inclusion of ineligible members or accounts on the exemption list,

especially if the credit union did not file CTRs because of the
inclusion; and
0 Lack of adequate internal controls, audit coverage, or inaccuracies
in the credit union’s training materials regarding BSA compliance.
Documenting FinCEN requires sufficient information to enable it to determine the

Violations severity of the problem and to decide whether to pursue a civil or
criminal action. NCUA refers significant violations of the BSA to
FinCEN for review for possible civil or criminal penalties. FinCEN
may assess civil and criminal penalties for willhl violations upon any
domestic financial institution, and upon any partner, director, officer,
or employee. Penalties can include both fines and prison terms.
FinCEN forwards potential criminal referrals to the Internal Revenue
Service - Criminal Investigation Division (IRS-CID) for investigation.
Examples of documentation necessary to support the referral of

violations of BSA include the following:
0 A description of the examination procedures used. The description

should note the “as of’ date of the information reviewed, whether
the examiner conducted a review of currency transactions and, if
so, the testing dates of the transactions;
0 A history of the credit union’s compliance with BSA;
0 A description of the violations. The description should contain
adequate detail to allow FinCEN to determine whether to pursue
enforcement action (e.g., name of the member or account, nature of
the member’s business, the member’s tax identification number,
and the purpose or type of transaction). The information regarding
the violation should identify the area or branch of the credit union
in which the violations occurred. If the violation involves ineligible
members or accounts on the exemption list, it should indicate
whether the credit union has on file exemption certificates for
additions to the list after October 27, 1986;
0 The credit union’s employer identification number (EN) and the
Magnetic Ink Character Recognition (MICR) number;
0 Identification of the individuals responsible for the violations or
having knowledge of the violation;
0 Credit union management’s response to the violations; and
Page 18A-25
EXAMINER'S GUIDE
0 For exemption list problems, the examiner may photocopy and

submit the exemption list. Examiners can note the absence of the
required exemption certification statement on the photocopy or
other problems with the list.
NCUA will submit copies of selected examination workpapers

summarizing the violations and other supporting documents with a
referral. Examiners may wish to obtain copies of source documents
(e.g., teller tapes or microfilm) to substantiate violations, but need not
submit all of the source documentation with the referral.
Examiners should maintain the following documentation for referred

cases:
For exemption violations:
- If the examiner questions the reasonableness of an exemption

or the business of an exempt member, the credit union should
provide documentation to support its position. Documentation
regarding exemptions may also include copies of credit union
statements, copies of letters to and from FinCEN or IRS,
internal credit union memoranda, and other items evidencing
cash flows and descriptions of the business;
- If an ineligible member has received an exemption, examiners
should retain copies of the Designation of Exempt Person
Treasury Form and documents stating the reasons why the
credit union believed that the member should receive the
exemption. In this case, examiners should direct the credit
union to contact the IRS Detroit Computing Center,
Compliance Review Group, Box 32063, Detroit, MI 48232 to
determine if the credit union must backfile CTRs;
0 For unreported transactions, examiners should retain in the

workpapers a copy of the source document identifjing the
transaction. The document may be a teller machine tape,
microfilm, cash idout ticket, selected portions of a computer
report, a debivcredit ticket, official applicatiodrequest, wire
transfer department documents, memoranda, or any other
documents which indicate that a reportable transaction occurred;
and
Page18A-26
0 For incomplete record keeping, documents may include copies of

signature cards, record retention schedules, or account documents
for which the credit union has failed to obtain a member's taxpayer
identification number. If the credit union's BSA Manual or internal
memoranda contains incorrect information regarding BSA,
examiners should retain copies of such documents noting the credit
union personnel responsible for approving, developing, or issuing
the document.
IRS Forms Credit unions may obtain IRS forms by calling the IRS Forms
Distribution Center at 1-800-829-3676, or by accessing the IRS web
site at www.irs.treas.gov/formsqubs/forms.html.Some forms are also
available from FinCEN's web site at www/treas.gov/fincen/forms.html.
Credit unions should file hardcopy forms with the U.S. Department of
the Treasury, P.O. Box 33 112, Detroit, Michigan 48232-01 12.
Magnetic media filers of these forms should mail magnetic
mediddiskettes to the IRS Detroit Computing Center, FinCEN, 985
Michigan Avenue, Detroit, Michigan 48226.
Credit unions may contact the IRS Detroit Computing Center at 1-800-
800-2877 for assistance with questions regarding CTR exemption
regulations (3 1 CFR Section 103.22(d)(2)), completion of the
Designation of Exempt Person Treasury Form (TD F 90-22.53),
completion of the CTR form (Form 4789), and CTR paper or magnetic
filing issues.
For other BSA related questions, credit unions and individuals may
call FinCEN's Regulatory Help line at 1-800-949-2732.
Page MA-27
REGULATORY FLEXIBILITY PROGRAM (REG FLEX)
APPENDIX 18B
Examination Determine whether federal credit unions qualify for exemptions or
0bjective additional authorities provided by the Regulatory Flexibility
Program (RegFlex)
Assoc iated 0 Liquidity risk - potential effect on the balance sheet liquidity due
Risks to large amount invested in high-risk investments, fixed assets, and
nonmember deposits;
0 Interest rate risk - potential effect on the balance sheet earnings due
to large amount invested in high-risk investments;
0 Strategic risk - could materially affect the balance sheet if
management overuses RegFlex and develops liquidity and earnings
problems; and
0 Reputation risk - earnings and net worth problems could cause the
membership to doubt the soundness of the credit union.
Overview A credit union is automatically eligible for the Regulatory Flexibility

(RegFlex) Program if it meets the following criteria:
0 Has a net worth of 9 percent; and

0 Has received a CAMEL rating of 1 or 2 for two consecutive
examinations.
Credit unions subject to risk-based net worth requirements under

NCUA Rules and Regulation 5702.103 must have net worth of 200
basis points over the risk based net worth level, or 9 percent,
whichever is higher.
Credit unions assigned a CAMEL 3 (or CAMEL 1 or 2 for less than

two consecutive cycles) with a net worth in excess of 9 percent (or
credit unions subject to a risk-based net worth requirement with net
worth at least 200 basis points over the risk based net worth
requirement), may apply to the regional director for a RegFlex
designation.
Page 18B-1
EXAMINER’S GUIDE
Credit unions can lose their eligibility for RegFlex if they no longer
meet the net worth or CAMEL requirements specified in $742.1. Also,
the regional director, for substantive and documented safety and
soundness reasons, may revoke a credit union’s RegFlex authority in
whole or part. The regional director must give a credit union written
notice stating the reasons for the action. Credit unions may appeal the
regional director’s decision to the NCUA Supervisory Review
Committee.
Exemptions Following are the specific exemptions credit unions receive under the
under RegFlex regulation:
RegFlex
0 Charitable donations. The RegFlex designation exempts charitable
donation limitations and the need for board approval. ($701.25)
0 Payment on shares by public unit and nonmembers. RegFlex

designation exempts public unit and nonmember share limitations
(20 percent of total shares or $1.5 million, whichever is greater).
Eligible credit unions must still appropriately manage the
nonmember shares and any additional risks, including volatility
and liquidity concerns. ($701.32(b) and $701.32(c))
FCU ownership of fixed assets. The RegFlex designation exempts

the fixed asset limitation (5 percent of shares and retained
earnings), eliminating the need to apply for a fixed asset waiver.
The credit union should still establish a fixed asset limitation and
incorporate the limit in a written business plan. Reg Flex status
does not eliminate the need for sound planning, including
developing reasonable and accurate financial projections.
($701.36(a), $701.36 (b), and $701.36 (c)) The RegFlex credit
union must continue to comply with $701.36(d) and $701.36(e).
0 Investment and deposit activities. RegFlex removes the limitation

on discretionary delegation of investments to third parties (100
percent of net capital at time of delegation.) RegFlex credit unions
should continue to establish their own limit, documented in a
Board-approved policy. ($703.40(~)(6))
Page 18B-2
REGULATORY FLEXIBILITY PROGRAM (REG FLEX) - APPENDIX 18A
0 Investment and deposit activities. RegFlex removes the

requirement for quarterly stress testing for those credit unions with
complex securities exceeding net capital that already measure the
impact of interest rate changes on their entire balance sheet as part
of their asset liability management programs. These credit unions
should continue to measure, at least quarterly, the impact of a
sustained, parallel shift in interest rates of plus and minus 300 basis
points on their entire balance sheet as part of their asset liability
management monitoring. (§703.90(c))
0 Investment and deposit activities. RegFlex removes the prohibition

of purchasing zero coupon investments with maturity date more
than ten years from the settlement date. (8703.1 1O(d))
Add itionaI RegFlex permits additional authority in the area of purchase, sale, and
Authority pledge of eligible obligations (9701.23) The RegFlex designation
under allows credit unions to purchase and retain any auto loan, credit card
RegFlex loan, member business loan, student loan, or mortgage loans from any
other credit union, without being subject the to the 5 percent limitation
of 8701.23 (b)(3), as long as the loans fall within the purchasing credit
union’s power to grant. The statutory limitations of credit unions
purchasing eligible obligations from liquidating credit unions remain
(i.e., 5 percent of unimpaired capital surplus of the purchasing credit
union.)
Exemptions If a state-chartered credit union meets the RegFlex criteria, then the
and credit union need not comply with §701.32(b) and §701.32(c). A state-
Add itional chartered credit union that only meets one of the two criteria may also
Authority for avail itself of the application process. However, RegFlex does not
FlSCUs preempt state law. The applicable state law must allow for public unit
and nonmember deposits. RegFlex provides the following exemption
to FISCUs that meet the RegFlex requirements:
0 Payment on Shares by Public Unit and Nonmembers. (§701.32(b)

and §701.32(c)) RegFlex designation exempts public unit and
nonmember share limitations (20 percent of total shares or $1.5
million, whichever is greater.) Eligible credit unions must still
Page 18B-3
EXAMINER'S GUIDE
appropriately manage the nonmember shares and any additional

risks, including volatility and liquidity concerns.
State regulators are responsible for notification to federally insured

state chartered credit unions (FISCUs) as to RegFlex eligibility. State
regulators are also responsible for subsequent monitoring of all
FISCUs eligible for exemptions under RegFlex.
Illustrations Illustrations 18B-1 through 18B-4 exhibit examples of letters to federal

credit unions regarding their RegFlex status.
Letter to FCU Date

Regardi ng
Denial of
Ms. Board Chairperson, Chair of the Board
Application
XXX Federal Credit Union
Address
City, State Zip Code
Dear Ms. Chairperson:
We reviewed your application for a RegFlex designation as provided

in Part 742 of NCUA Rules and Regulations. [XXX Federal Credit
Union] currently does not meet the [CAMEL or net worth] criteria of
$742.1. [Insert discussion of justification for denial.]
Please contact your district examiner or the supervision analyst in this

office with any questions.
Sincerely,
Jane Doe
Regional Director
Illustration 18B-1
Page 18B-4
Letter to FCU Date

Meeting
RegFlex
Board of Directors
Criteria
Address
Dear Board of Directors:
[XXX Federal Credit Union] is eligible for a RegFlex designation as

provided in Part 742 of NCUA Rules and Regulations due to advanced
levels of net worth and consistently strong supervisory examination
ratings. Regulatory relief is awarded with this designation as described
in 5742.4 and 5742.5. Additionally, enclosed is a summary of the
regulations you are exempt or given additional authority.
Please contact your district examiner or a supervision analyst in this

Sincerely,
JC-JI Doe
Regional Director
Illustration 18B-2
Page 18B-5
EXAMINER'S GUIDE
Letter to FCU Date

No Longer
Meeting
Board of Directors
RegFlex
Criteria XXX Federal Credit Union
Address
[XXX Federal Credit Union] is no longer eligible for a RegFlex

designation as provided in Part 742 of NCUA Rules and Regulations
due to a [decline in net worth] [CAMEL rating downgrade]. Because
of this, [XXX Federal Credit Union] is not eligible for the regulatory
relief provided in Section 742.4 and 742.5. Any action by [XXX
Federal Credit Union] while under the RegFlex authority will be
grandfathered. Future actions must meet all NCUA's regulatory
requirements.

Sincerely,
John Doe
Regional Director
Illustration 18B-3
Page 18B-6
Revocation Date
Letter to FCU
Board of Directors
Address
[XXX Federal Credit Union] is no longer eligible for a RegFlex

designation as provided in Part 742 of NCUA Rules and Regulations
due to substantive safety and soundness reasons. [Insert paragraph
justifying substantive and documented safety and soundness reasons.]
Any action by [XXX Federal Credit Union] while under the RegFlex
authority will be grandfathered. Future actions must meet all NCUA's
regulatory requirements. [Insert paragraph, as appropriate, emphasizing
Regulations the credit union is no longer exempt where limitations are
needed for safety and soundness concerns (i.e., fixed asset limitation).]
You may appeal this decision within 60 days from the date of
determination to the NCUA Supervisory Review Committee
(Committee). This decision will remain in effect unless the Committee
issues a different determination. If you are dissatisfied with the
Committee decision, you may appeal to the NCUA Board within 60
days from the issuance of the Committee decision.

Sincerely,
John Doe
Regional Director
Illustration 18B-4
Page 18B-7
/fB-f&&JJ
MONEY LAUNDERING RED FLAGS
Member 0 Refusal or reluctance to proceed with a transaction, or abruptly
Transactions withdrawing a transaction. A member may be reluctant or even
withdraw a transaction after being informed that a Currency
Transaction Report (CTR) will be filed, or that the purchase of a
monetary instrument will be recorded. The member may withdraw
all or a portion of the transaction to avoid Bank Secrecy reporting
requirements.
0 Member refusal or reluctance to provide information or

identification. A member may be reluctant, or even refuse to
provide identifying information when opening an account, cashing
a check, recording the purchase of a monetary instrument, or
providing information necessary to file a Currency Transaction
Report.
Structured or recurring, non-reportable transactions. An individual

or group may attempt to avoid Bank Secrecy Act reporting and
record keeping requirements by breaking up, or structuring a
currency transaction or purchase of monetary instruments in
amounts less than the reportinglrecord keeping thresholds.
Transactions may also be conducted with multiple branches,
member service representatives, accounts and/or on different days
in attempt to avoid reporting requirements.
0 Multiple third parties conducting separate, but related, non-

reportable transactions. Two or more individuals may go to
different tellers or branches and each conduct transactionsjust
under the reportinghecordkeeping threshold.
0 Even dollar amount transactions. Numerous transactions are

conducted in even dollar amounts. NOTE: Money laundering and
check kiting schemes have similar characteristics.
0 Transactions structured to lose the paper trail. The credit union

may be asked to process internal debits or credits containing
minimal or no description in attempt to “separate” a transaction
from its account.
Attachment 18.1
EXAMINER’S GUIDE
Significant increase in the number or amount of transactions. A

large increase in the number of or amount of transactions involving
currency or non-cash items, the purchase of monetary instruments,
wire transfers, etc. may indicate potential money laundering.
0 Transactions that are not consistent with the member’s business or

income level.
0 Multiple accounts with numerous deposits under $10,000.
0 Numerous cash deposits under $10,000 in a short period of time.

This includes deposits made at an ATM.
0 Accounts with high volume of activity and low balances. Accounts

with a high volume of activity, which carry a low balance or is
frequently overdrawn, may be indicative of money laundering or
check kiting.
0 Accounts with large deposits and balances. A member makes large

deposits and maintains large balances with little or no apparent
justification.
0 Deposits and immediate request for wire transfers or cash

shipments.
Numerous deposits of small incoming wires or monetary

instruments, followed by a large outgoing wire.
Accounts used as a temporary repository of funds. The member

appears to use the account as a temporary repository for funds that
will be transferred out of the credit union. There is little account
activity.
0 Funds deposited into several accounts, transferred to another

account, and then transferred outside the U.S.
0 Disbursement of certificates of deposit by multiple checks, each

under $10,000.
0 Early redemption of certificates of deposit.
Attachment 18.1
EXAMINER’S GUIDE
0 Inconsistent deposit and withdrawal activity by a member with a

retail business account.
Strapped currency. Frequent deposits of large amounts of currency,

wrapped in currency straps that have been stamped by a bank.
0 Large amounts of food stamps not consistent with the members

legitimate business.
0 Transactions by non-account holders. A non-member conducts or

attempts to conduct transactions such as currency exchanges, or the
purchase or redemption of monetary instruments for no apparent
legitimate reason.
Cash 0 Change in currency shipment patterns. Significant changes in

Management currency shipment patterns between vaults, branches, and/or
correspondent banks may indicate a potential money laundering
scheme occurring in a particular location.
0 Large increase in cash supply or a large increase in the size and

frequency of cash deposits with no corresponding increase in non-
cash deposits.
Significant exchanges of small denomination bills for large

denomination bills. (See cash shipment records.)
Significant requirement for large bills. Branches whose large bill

requirements are significantly greater than average may be
conducting large currency exchanges. Branches that suddenly stop
shipping large bills may be using them for currency exchanges.
International cash shipments funded by multiple monetary

instruments. This involves the receipt of funds in the form of
multiple official bank checks, traveler’s checks, or personal checks
that are drawn on or issued by U.S. financial institutions. They
may be made payable to the same individual or business, or related
individuals or businesses, and may be in U.S. dollar amounts
below the Bank Secrecy Act reportinghecord keeping threshold.
Attachment 18.1
EXAMINER’S GUIDE
Funds are then shipped or wired to a financial institution outside

the U.S.
0 Other unusual domestic or international shipments. For example,

the member directs the credit union to ship funds to a foreign
country and advises the credit union to expect same day return of
funds from sources different than the beneficiary named, thereby
changing the source of the funds.
0 Frequent cash shipments with no apparent business reason.
Currency
Exchanges 0 Unusual exchange of denominations. An individual or group seeks
and Other the exchange of small denomination bills (five, ten and twenty
Currency dollar bills) for larger denomination bills without any apparent
Transactions legitimate business reason.
0 Check cashing companies. Large increases in the number and/or

amount of cash transactions from a member who owns a check
cashing business.
0 Unusual exchange by a member who is in the check cashing

business. No exchange or cash-back for checks deposited by an
individual who owns a check cashing service can indicate another
source of cash.
0 Suspicious movement of funds. Suspicious movement of funds out

of a bank into the credit union and back in to the bank or vise versa
can indicate money laundering.
Lending 0 Certificates of deposits used as collateral. An individual buys

certificates of deposit and uses them as loan collateral. Illegal
funds can be involved in either the CD purchase or the use of the
loan proceeds.
Sudden unexpected payment on loans. A member may suddenly

pay down or pay off a large loan, with no evidence of refinancing
or other explanation.
Attachment 18.1
EXAMINER’S GUIDE
Reluctance on the part of the member to provide the purpose of the

loan or the stated purpose is ambiguous. The Bank Secrecy Act
requires the credit union to document the purpose of all loans over
$10,000.
Inconsistent or inappropriate use of loan proceeds. The proceeds

are used for other than the stated purpose.
Overnight loans. A member may use “overnight” loans to create

high balances in the account.
Loan payments received from third parties. Loans repaid by a third

party may indicate that the assets securing the loans are really
those of a third party, who is attempting to hide the ownership of
illegally, gained funds.
Loan proceeds used to purchase property in the name of a third

party, or collateral pledged by a third party.
Permanent mortgage financing with an unusually short maturity.
Structured down payments or escrow money transactions to

conceal the true source of the funds.
Attempt by the member or the credit union to sever a paper trail

connecting a loan with the security for the loan.
Wire transfer of loan proceeds for no apparent reason.
Disbursement of loan proceeds by multiple credit union checks,

each under $10,000.
Loans to members or businesses outside the U.S. Unusual loans to

members in offshore locations, such as “secrecy havens”.
Financial statement of a member’s business which differs greatly

from those of similar businesses.
Attachment 18.1
EXAMINER’S GUIDE
Monetary 0 Structured purchases of monetary instruments (traverlers checks or

Instruments money orders) An individual or group purchases monetary
instruments with currency in amounts below the $3,000 reporting
threshold.
0 Replacement of monetary instruments. An individual uses one or

more monetary instruments to purchase another monetary
instrument.
0 Frequent purchase of monetary instruments without apparent

legitimate reason.
Deposit or use of multiple monetary instruments. The deposit or

use of numerous official bank checks or other monetary
instruments, all purchased on the same date at different issuers.
These instruments may or may not be payable to the same
individual or business.
Incomplete or fictitious information. The member may conduct

transactions involving monetary instruments that are incomplete or
contain fictitious payees or remitters.
0 Large cash amounts. The member may purchase traveler’s checks,

money orders, or credit union checks with large amounts of cash.
Safe Deposit
Boxes 0 Frequent visits. The member may visit the box on an unusually
frequent basis.
Out of area members. The safety deposit box may be opened by a

member who does not reside or work in the credit union’s location.
0 Change in safety deposit box traffic. For example, more people

may enter or may enter more frequently, or the member may carry
bags or other containers that could conceal large amounts of cash.
0 Large amounts of cash maintained in a safe deposit box. A member

may access the safety deposit box after completing a transaction
involving a large withdrawal of cash, or may access the safety
Attachment 18.1
/d
1r-E)-
EXAMINER’SGUIDE
deposit box prior to making cash deposits which are just under
$10,000.
0 Multiple safety deposit boxes. A customer may rent multiple safe

deposit boxes if storing large amounts of currency.
Wire 0 Wire transfer to bank secrecy haven countries.

Transfers
0 Incoming\Outgoing wire transfers with instructions to pay upon
proper identification. The instructions to the receiving financial
institution are to “pay upon proper identification.” If paid for in
cash, the amount may be just under $10,000 so no Currency
Transaction Report is required. The purchase may be made with
numerous official checks or other monetary instruments. The
amount of the transfer may be large, or the funds may be sent to a
foreign country.
0 Outgoing wire transfers requested by non-members. If paid in

cash, the amount may be just under $10,000 to avoid a Currency
Transaction Report. The funds may also be paid with several
official checks or other monetary instruments or the funs may be
directed to a foreign country.
Frequent wire transfers with no apparent business reason.
0 High volume of wire transfers with low account balances.
0 Incoming and outgoing wires in similar dollar amounts. There is a

pattern of wire transfers of similar amounts both in and out of the
member’s account, or related members, on the same day or the
next day. The member may receive many small incoming wires,
and then order a large outgoing wire transfer to another city or
country.
0 Large wires by members operating a cash business. Could involve

wire transfers by members operating a mainly cash business.
Attachment 18.1
EXAMINER’S GUIDE
Cash or bearer instruments used to fund wire transfers. Use of

cash or bearer instruments to fund wire transfers may indicate
money laundering.
Unusual transactions by correspondent financial institutions.

Suspicious transactions would include (1) wire transfer volumes
that are extremely large in proportion to the asset size of the credit
union; or (2) a large volume of wire transfers of similar amount in
and out on the same day or the next day.
International funds transfers which are not consistent with the

member’s business.
International transfers funded by multiple monetary instruments.

This involves the receipt of funds in the form of multiple official
checks, or traveler’s checks that are drawn on or issued by US.
financial institutions and made payable to the same individual or
business or related individuals or businesses in U.S. dollar amounts
that are below the Bank Secrecy Act reporting threshold. The
funds are then wired to a financial institution outside the U.S.
Other unusual domestic or international funds transfers. The

member requests an outgoing wire or is the beneficiary of an
incoming wire, and the instructions appear inconsistent with
normal wire transfer practices. For example: The member directs
the credit union to wire the funds to a foreign country and advises
the credit union to expect same day return of funds from sources
different than the beneficiary named, thereby changing the source
of the funds.
No change in form of currency. Funds or proceeds of a cash

deposit may be wired to another country without changing the
form of currency.
Other Questions or discussions on how to avoid reportingkecord

Activities keeping. This involves discussions by members or employees
about ways to bypass the filing of a Currency and Transaction
Reports or the recording of the purchase of a monetary instrument.
Attachment 18.1
EXAMINER’S GUIDE
Member attempts to influence a credit union employee not to file a

report. This would involve any attempt by an individual or group
to threaten, bribe, or otherwise corruptly influence a bank
employee to bypass the filing of a Currency Transaction Report,
recording of purchases of monetary instruments of filing a
Suspicious Activity Report.
Lavish lifestyles of customers or credit union employees. Lavish

lifestyles of customer or employees, which are not supported by
their current salary, may indicate possible involvement in money
laundering activities.
0 Short-term or no vacations. A credit union employee may no

vacation or only take short vacations.
0 Circumvention of internal control procedures. Overrides of internal

controls, recurring exceptions, and out of balance conditions may
indicate money laundering activities. For example, credit union
employees may circumvent wire transfer authorizations and
approval policies, or could split wire transfers to avoid ceiling
limitations.
0 Incorrect or incomplete CTRs. Employees may frequently submit

incorrect or incomplete Currency Transaction Reports.
Definitions Monitory Instruments consist of the following:

0 United States coins and currency
0 Coins and currency of a foreign country (as prescribed by the
Secretary of Treasury).
0 Traveler’s checks, bearer negotiable instruments, bearer
investment securities, bearer securities, stock on which title is
passed on delivery and similar material.
0 Checks, drafts, notes, money orders, and other similar instruments,
which are drawn on or by a foreign financial institution.
Attachment 18.1
/v.c3-/7, / B n - / a u
Chapter I 9
CONSUMER COMPLIANCE
TABLE OF CONTENTS
CONSUMER COMPLIANCE ........................................................................................ 19. 1

Risk Categories .................................................................................................... 19. 1
Overview............................................................................................................. .l 9.1
Consumer Compliance Program .......................................................................... 19-2
Field Examiners ....................................................................................... 19.2
Compliance Subject Matter Examiners ................................................... 19-2
Regional Compliance Analysts ................................................................ 19-3
Compliance Program Officer (EM) ......................................................... 19-4
Examination Procedures ...................................................................................... 19.4
State Chartered Credit Unions ................................................................. 19-5
Additional Information ........................................................................................ 19.5
APPENDIX 19A .Credit Practices Rule ........................................................................ . 1 A. 91
APPENDIX 19B .Equal Credit Opportunity Act .......................................................... .19B.1
APPENDIX 19C .Home Mortgage Disclosure Act ........................................................ 19C-1
APPENDIX 19D - Expedited Funds Availability Act .................................................... 19D-1
APPENDIX 19E - Children’s Online Privacy Protection Act ....................................... . 1 E.
91
APPENDIX 19F - Electronic Funds Transfer Act ......................................................... . 1 F.
91
APPENDIX 19G - E-Sign Act ........................................................................................19 G.l
APPENDIX 19H - Fair Credit Reporting Act ................................................................ . 1 H. 91
APPENDIX 191- Fair Debt Collection Practices Act .................................................... .191-1
APPENDIX 19J - Fair Housing Act ................................................................................ 195-1
APPENDIX 19K - Flood Disaster Protection Act ......................................................... . 1 K. 91
APPENDIX 19L - Homeowners Protection Act ............................................................. 191-1
APPENDIX 19M - Consumer Leasing Act.................................................................... . 1 M. 91
APPENDIX 19N - Privacy of Consumer Financial Information .................................... 19N-1
APPENDIX 1 9 0 - Real Estate Settlement Procedures Act ............................................ 190-1
APPENDIX 19P - Right To Financial Privacy .............................................................. . 1 P. 91
APPENDIX 19Q - Soldiers’ and Sailors’ Civil Relief Act ............................................ .19Q.l
APPENDIX 19R - Homeownership and Equity Protection Act .................................... . 1 R. 91
APPENDIX 19s - Truth In Lending Act ........................................................................ 195-1
APPENDIX 19T - Truth in Savings Act ......................................................................... 19T-1
Chapter I 9
CONSUMER COMPLIANCE
Examination 0 Determine whether the credit union complies with consumer
Objectives compliance regulations
0 Determine whether the credit union protects its members from
violations of their consumer rights
0 Determine whether the credit union initiates corrective action if it
becomes aware of consumer compliance violations
Risk 0 Compliance risk can occur when the credit union fails to
Categories implement the necessary controls to comply with appropriate
consumer compliance regulations; and
0 Reputation risk can occur when the credit union incurs fines,
penalties, and poor publicity as a result of failure to comply with
the appropriate consumer compliance regulations; and
0 Strategic risk can occur when management fails to perform
adequate planning and due diligence in regard to consumer
compliance regulations.
Overview NCUA is the federal agency assigned with the enforcement authority
for a broad range of consumer regulations that apply to federally-
chartered credit unions and, to a lesser degree, federally insured state-
chartered credit unions. This authority confers to examiners’
responsibility for providing a satisfactory level of oversight for
compliance activities. This oversight is necessary in order to:
0 Assure credit union members that their credit union meets the
required statutory and regulatory requirements for which NCUA
has oversight enforcement responsibility; and
0 Provide adequate reporting to Congress.
Compliance risk obviously exists in blatant violations of law.

However, it may also arise in situations where ambiguous or untested
laws or rules govern certain credit union products or member
activities. Compliance risk exposes the credit union to fines, civil
Page 19-1
EXAMINER’S GUIDE
money penalties, payment of damages, and the voiding of contracts. It

can result in diminished reputation, limited opportunities, reduced field
of membership expansion potential, and lack of contract enforceability.
Consumer NCUA’s Consumer Compliance Program uses a tiered approach to

Cornpliance compliance using field examiners, compliance subject matter
Program examiners (SMEs), regional compliance analysts, and the Office of
Examination and Insurance compliance program officers. The program
strives to balance (1) examiners’ knowledge of consumer compliance
laws, (2) the need for an efficient, risk-focused use of resources, and
(3) the responsibility for collecting reliable data about the credit
union’s compliance practices.
Field Examiners provide basic compliance oversight in the course of the

Examiners risk-focused examination program or insurance review. A credit
union’s compliance risk profile can change rapidly due to innovation
of products and services, changes in regulation, competitive pressures,
field of membership expansion, and the revolution in information
technology.
Examiners identify the level of risk inherent in a credit union’s

consumer compliance activities based on the complexity of operations,
management’s level of due diligence regarding compliance issues for
existing, new, and proposed products and services, and the extent to
which management devotes resources to ensure compliance. For
example, in large, complex credit unions with resident compliance
personnel, examiners may limit their reviews. They may discuss the
credit union’s compliance policies and practices with staff responsible
for ensuring compliance and monitoring requirements. In contrast, the
focus at smaller credit unions or credit unions with limited internal
controls may include verifying information through more extensive
transaction testing.
Compliance SMEs serve as resource persons for field examiners. They provide
Subject Matter advice and support to examiners. SMEs assist the examiners by
Examiners providing specific guidance in their area of expertise.
Page 19-2
CONSUMER COMPLIANCE
During the planning process, examiners may request and arrange

through their supervisory examiners for participation of an SME on a
particular examination. Requesting a compliance SME may be
appropriate when examiners deem a high risk exists in the compliance
area, in large complex credit unions with substantial compliance
exposure, in credit unions that have not received a compliance review
for several examinations, or in other cases where the examiner can
support the need for a SME. Examiners must balance their request for
resources with existing or potential risk.
SMEs will receive training and resource material to assist them in

providing this additional level of support, assistance, and guidance to
examiners. Examiners may refer (with supervisory examiner
concurrence) unresolved compliance issues or evidence or suspicion of
noncompliance to the regional compliance analyst for further action.
Regional Regional compliance analysts serve as the regional point of contact.

Compliance They monitor training needs, provide applicable training, and perform
Analysts in-depth compliance reviews. Information from the following sources
may trigger a compliance review:
0 The risk-focused examination process;

The Consumer Regulation Violation Log (CRVL);
Home Mortgage Disclosure Act (HMDA) data or similar
information;
0 Member complaints;
Referral by another government entity; or
Random sample.
Regional compliance analysts manage, coordinate, and collect

compliance data within the region for reporting purposes. These duties
include:
0 Serving as the regional compliance expert for SMEs and field

examiners;
0 Analyzing regional compliance information to assist in directing
special examination procedures; and,
0 Reviewing the accuracy of the region’s reported violations.
Page 19-3
EXAMINER’S GUIDE
Regional analysts also serve as contacts for credit union personnel

requesting assistance or information on consumer regulations. For
example, the regional compliance analysts receive annual HMDA data
for the region, which they review to determine compliance and fair
lending risks. They will consider credit unions displaying significant
compliance risk for a fair lending review. The regions determine which
credit unions, if any, should receive fair lending reviews.
Compliance The compliance program officer serves as the agency contact in the
Program area of consumer compliance regulation and enforcement. The
Officer (E&l) compliance program officers are responsible for:
Coordinating the collection of data for reporting purposes to

Congress and others;
0 Development of training programs (based on regional input) for
field staff, SMEs, and regional compliance analysts, and
0 Development of examination and supervision activities for
compliance matters.
The compliance program officers serve as resource persons for

regional compliance analysts and interfaces with other governmental
agencies and offices, e.g. FFIEC.
Examination Examiners may use their discretion to determine the level of review of
Procedures a credit union’s consumer compliance program. Factors that may lead
an examiner to consider an increased risk exists in the compliance area
resulting in the need to expand the examination scope include:
0 New products or services offered by the credit union that fall under
a consumer compliance regulation;
0 New consumer compliance regulation affecting the credit union
industry;
0 A change in credit union staff responsible for compliance with
consumer laws;
0 Length of time since an NCUA examiner performed a review of
the area;
0 Volume and severity of consumer complaints; or
Page 19-4
CREDIT PRACTICES RULE - APPENDIX 19A
Examination 0 Determine whether the credit union’s loan contracts are free from
Objectives prohibited credit practices
0 Determine whether the credit union accurately represents a
cosigner’s obligation and provides a notice to cosigner
0 Determine whether the credit union’s method of collecting late
charges complies with the regulation
0 Determine whether the credit union initiates corrective action if it
becomes aware of a violation
Categories implement the necessary controls to comply with the Credit
Practices Rule; and
0 Reputation risk can occur when the credit union incurs fines and
penalties as a result of failure to comply with the Credit Practices
Rule.
Overview Part 706 of the NCUA Rules and Regulations implements the
requirements of Subpart B of Regulation AA, also known as the Credit
Practices Rule, for federal credit unions. The regulation defines unfair
or deceptive acts or practices of credit unions in connection with
extensions of credit to consumers. The Federal Trade Commission
(FTC) has enforcement authority for the Credit Practices Rule for
state-chartered credit unions.
The Credit Practices Rule is broken down into three parts:
0 Unfair Credit-Contract Provisions;

0 Unfair or Deceptive Practices Involving Cosigners; and
0 Unfair Late Charges.
Contract It is an unfair act or practice for a credit union, directly or indirectly, to

Provisions take or receive from a member an obligation in connection with the
extension of credit that:
Page 19A-1
EXAMINER'S GUIDE
0 Constitutes or contains a cognovit or confession of judgment,

warrant of attorney, or other waiver of the right to notice and the
opportunity to be heard in the event of suit or process thereon;
Constitutes or contains an executory waiver or a limitation of
exemption from attachment, execution, or other process on real or
personal property held, owned by, or due to the consumer, unless
the waiver applies solely to property subject to a security interest
executed in connection with the obligation; or
0 Constitutes or contains an assignment of wages or other earnings
unless:
- The assignment by its terms is revocable at the will of the

debtor, or
- The assignment is a payroll deduction plan or preauthorized
payment plan, commencing at the time of the transaction, in
which the member authorizes a series of wage deductions as a
method of making each payment, or
- The assignment applies only to wages or other earnings already
earned at the time of the assignment
0 Constitutes or contains a nonpossessory security interest in

household goods other than a purchase money security interest.
Cosigners In connection with the extension of credit to members, it is:
0 A deceptive act or practice for a credit union, directly or indirectly,

to misrepresent the nature or extent of cosigner liability to any
person; or
0 An unfair act or practice for a credit union, directly or indirectly, to
obligate a cosigner unless the cosigner is informed prior to
becoming obligated.
To comply with the cosigner notification requirement, credit unions

must provide a clear and conspicuous disclosure statement in writing
to the cosigner prior to becoming obligated. The notice may be a
separate document or included in the documents evidencing the
consumer credit obligation.
Page 19A-2
CREDIT PRACTICES RULE - APPENDIX 19A
Late Charges In connection with collecting a debt arising out of an extension of

credit to a member, it is an unfair act or practice for a credit union,
directly or indirectly, to levy or collect any delinquency charge on a
payment, if the payment is otherwise a full payment for the applicable
period and is paid on its due date or within an applicable grace period,
when the only delinquency is attributable to late fees or delinquency
charges assessed on earlier installments. To do so would constitute
“pyramiding” late fees.
Example: A member’s payments are $40 a month. The member makes the
February payment in full, but makes it late. The credit union assesses a $5 late
charge. The member makes a March payment of $40 on time, but fails to pay the
$5 late charge. The credit union uses part of the March payment to pay off the
outstanding late charge, and then considers the March payment deficient. The
credit union may not assess another late charge since the March Dayment was
made in full and on time.
Examination An examiner may perform one or more of the following examination

Procedures procedures, depending on the scope of the review.
0 Evaluate loan contracts to determine whether they are free fiom

prohibited credit practices;
0 Review the late payment accounting process to verify whether it
complies with the prohibition of pyramiding late fees;
0 Review cosigned loans and verify that the credit union provided a
written notice to cosigner;
0 Complete the Credit Practices Rule checklist in AIRES, which
provides informative guidance on the requirements of the
regulation for each question; and
0 Report a violation of the Credit Practices Rule on the Violations
form in AIRES.
Add itional Additional information is available in Part 706 of NCUA Rules and
Information Regulations. In addition, the Staff Commentary on Regulation AA
provides question and answer examples. Examiners can access it at
www.federalreserve.gov.
Page 19A-3
EQUAL CREDIT OPPORTUNITY ACT - APPENDIX
Examination Determine whether the credit union discriminates in the granting of

0bjectives credit on any of the bases prohibited by the Equal Credit
Opportunity Act (ECOA)
Determine if the credit union has procedures in place for
complying with the requirements of the ECOA
Risk Compliance risk can occur when the credit union fails to
Categories implement the necessary controls to comply with the ECOA; and
Reputation risk can occur when the credit union incurs fines and
penalties as a result of failure to comply with ECOA.
Overview The purpose of the Equal Credit Opportunity Act (ECOA) is to

promote availability of credit to all creditworthy applicants without
regard to race, color, religion, national origin, sex, marital status, age
(provided the applicant has the capacity to contract), receipt of public
assistance, or good faith exercise of any rights under the Consumer
Credit Protection Act.
The basic rule of the ECOA, also known as Regulation B, as found in

$202.4, is:
"A creditor shall not discriminate against any applicant on a

prohibited basis with respect to any aspect of a credit transaction."
Prohibited basis refers not only to the characteristics of the applicant

but also to the characteristics of individuals with whom the applicant is
affiliated or with whom the applicant associates. Therefore, a credit
union may not discriminate against a member-applicant based on a
prohibited basis characteristic of an associated individual. For
example, a credit union cannot discriminate against an applicant
because of the race of the residents in the neighborhood where the
collateral property is located.
Page 19B-1
EXAMINER’S GUIDE
Credit transaction means every aspect of an applicant’s dealings with a

credit union regarding an application for credit or an existing extension
of credit including, but not limited to, information requirements,
investigation procedures, standards of creditworthiness, terms of
credit, furnishing of credit information, revocation, alteration, or
termination of credit, and collection procedures.
Regulation B also requires credit unions to do the following:
0 Notify applicants of the credit decision within 30 days of receiving

a completed application;
0 Retain records of credit applications for 25 months after notifling
the member of its credit decision;
0 Collect information about the applicant’s race and other personal
characteristics in applications for certain dwelling-related loans;
and,
0 Provide applicants with copies of appraisal reports used in
connection with credit transactions.
Credit Regulation B prevents credit unions from discouraging prospective

Applications applicants from making or pursuing an application.
Credit unions should use industry standard form applications. A credit

union choosing to use a non-standard credit application form should
obtain a legal opinion stating the forms comply with the applicable
legal requirements.
The application may request any information, except for the following:
Information about the member’s spouse, unless the spouse will use
or is contractually liable on the account or the applicant relies on
the spouse’s income;
0 Information about the member’s marital status when applying for
unsecured credit; when applying for secured credit, the application
may use only the terms married, unmarried, or separated;
Information about the member’s sex, race, color, religion, and
national origin; and,
0 Information about childrearing or childbearing such as birth control
practices, intentions, or capability to bear children.
Page 19B-2
EOUAL CREDIT OPPORTUNITY ACT - APPENDIX 19B
A credit union may consider any information obtained in the credit

application provided it does not use the information to discriminate
against an applicant on a prohibited basis. An exception to this rule
relates to the consideration of age in determining an applicant’s
creditworthiness.
Effects Test While not specifically mentioned in the ECOA, the legislative history
of the ECOA indicates Congress intended an “effects test” concept to
apply to a credit union’s determination of creditworthiness. The effects
test refers to a credit practice that appears facially neutral, but has a
disproportionately negative effect on a prohibited basis, even though
the credit union has no intent to discriminate. This type of practice is
discriminatory, in effect, unless the credit union can demonstrate the
practice meets a legitimate business need that cannot be reasonably
achieved by means less disparate in impact.
Answering the following questions should assist the examiner in

determining if the credit union’s credit practices result in a potential
violation of the effects test:
1. Does a particular credit practice have a statistically

disproportionate impact on a protected group (those covered under
the prohibited basis definition)?
2. If so, can the credit union show that the practice serves a genuine
business need?
3. If so, is there a less discriminating way to meet that business need?
Appraisals Credit unions subject to NCUA’s regulations are not subject to the
appraisal requirements of the ECOA. However, NCUA Rules and
Regulations 9703.1(c)(5) requires a credit union to make available to
any requesting member a copy of the appraisal used in conjunction
with that member’s real estate loan application. The credit union must
make that appraisal available for 25 months after the member was
notified of the action taken on the credit application.
Enforcement The National Credit Union Administration Board has responsibility for
enforcement among federal credit unions, while the Federal Trade
Page 19B-3
EXAMINER'S GUIDE
Commission enforces Regulation B for state-chartered credit unions

(12 C.F.R. Part 202 Appendix A). Regulation B contains a civil
liability provision. Examiners should determine the adequacy of each
credit union's compliance with Regulation B during routine
examinations by evaluating patterns and practices. Examiners should
note violations, and obtain agreements with management for prompt
correction of violations.

Procedures procedures, depending on the scope of the review:
Determine whether the credit union has established policies and

procedures with regard to Equal Credit Opportunity;
Determine that all applicable forms (i.e., applications and adverse
action notifications) are neutral in terms such as sex; titles are
optional; married, unmarried, and separated are the only marital
status terms used, etc. When the credit union uses nonstandard
forms, the examiner should ask the credit union to provide a legal
opinion supporting the use of the forms;
Determine that the credit union complies with the adverse action
notification requirements;
Determine that the credit union maintains appropriate records as
required by the regulation;
Determine that the credit union requests and documents the
monitoring information on real estate related applications;
Complete the applicable Regulation B checklist in AIRES, which
regulation for each question; and
Notify the supervisory examiner if a pattern or practice of ECOA
violations becomes evident in the examination process and report
the violation on the Violations form in AIRES.
Add itionaI The Federal Reserve Board's website contains additional information
Information at htto://www.federalreserve.gov. The Publications Services Unit at
(202) 452-3245 has copies of the regulation and staff commentaries
issued by the Federal Reserve System available.
Page 19B-4
HOME MORTGAGE DISCLOSURE ACT - APPENDIX
19c
Examination 0 Determine whether the credit union meets the criteria that triggers
Objectives HMDA reporting
0 Determine whether the credit union complies with the reporting
requirements of the Act and Regulation
0 Determine whether the credit union has implemented adequate
policies, practices, and internal controls to ensure compliance with
the Act and Regulation
Categories implement the necessary controls to comply with HMDA; and
penalties as a result of failure to comply with HMDA.
HMDA - Regulation C implements the requirements of the Home Mortgage

Regulation C Disclosure Act (HMDA). It requires certain credit unions and credit
union service organizations to report data about home purchase and
home improvement loans they originate, purchase, or for which they
receive applications. In general, they must report:
0 Data about each application or loan (such as loan type and amount)
and the location of the dwelling to which it relates; and
0 The race or national origin, sex, and gross annual income of the
applicant or borrower.
The purpose of Regulation C is to provide the public with data that can
be used to:
0 Help determine whether credit unions serve the housing needs of

their communities;
0 Assist public officials in distributing public-sector investments in
order to attract private investment to areas needing it; and,
0 Assist in identifying possible discriminatory lending patterns and
enforcing compliance with anti-discrimination statutes.
Page 19C-1
EXAMINER'S GUIDE
Regulation C is not intended to encourage unsound lending practices

or the extension of credit.
Exempt A credit union is exempt from the requirements of the regulation for a
Institutions given calendar year if on the preceding December 3 1:
0 It had neither a home office nor a branch office in a metropolitan

statistical area (MSA);
0 Total assets were at or below the threshold established by the
Federal Reserve Board (Board). The Board adjusts the threshold
based on the year-to-year change in the average of the Consumer
Price Index for Urban Wage Earners and Clerical Workers, not
seasonally adjusted, for each twelve-month period ending in
November, with rounding to the nearest million. NCUA notifies
credit unions about the asset threshold change each year in a
Regulatory Alert;
0 It made no first-lien home purchase loans (including refinancings
of home purchase loans) on one-to-four family dwellings in the
preceding calendar year.
Disclosure Non-exempt credit unions must maintain a loadapplication register

and Reporting (LAR) on which it will enter data about each application received and
each loan originated and purchased. The credit union must send the
LAR to its supervisory agency by March 1 following the calendar year
to which the loan data relate.
The credit union must make its mortgage loan disclosure statement
(provided by the Federal Financial Institutions Examination Council
(FFIEC)) available to the public at its home office no later than three
business days after receiving it. In addition, if a credit union has branch
offices in other MSAs, it must make disclosures available using one of
two options:
0 It can make the statement available in at least one office in each of

those MSAs, within ten business days of receipt from the FFIEC;
or
0 It can send a copy of the statement if someone makes a written
request, within fifteen calendar days of receiving the request. If the
Page 19C-2
HOME MORTGAGE DISCLOSURE ACT - APPENDIX 19C
credit union chooses this option, it must post the address for
requesting copies in each branch office in an MSA.
Enforcement NCUA enforces compliance with HMDA for all credit unions required
to report and may impose administrative sanctions, including the
imposition of civil money penalties. NCUA does not consider it an
error in compiling or recording required data a violation of the
regulation if it was unintentional and occurred despite the credit
union’s maintenance of procedures reasonably adopted to avoid such
errors.

Determine whether the credit union has adequate procedures in

place for collecting and maintaining accurate data regarding each
loan application, loan origination, and purchase of loans;
Assess whether the individuals responsible for preparing and
maintaining the data understand the regulatory requirements and
have the resources and tools needed to produce complete and
accurate data;
0 Determine whether the credit union accurately submitted its
HMDA-LAR in an automated, machine-readable form or via
Internet email (credit unions that report 25 or fewer entries may
report the data in paper form);
0 Verify that the credit union properly retains a copy of the register;
and
0 Determine whether the credit union makes the mortgage loan
disclosure statements available in its home office and branch
offices located in MSAs by the applicable deadline.
Add itional Credit unions engaged in mortgage lending should obtain the
Information publication A Guide to HMDA Reporting: Getting it Right! Credit
unions may obtain a copy from the NCUA publications office or they
can download it from the NCUA web site at www.ncua.gov.
Page 19C-3
EXPEDITED FUNDS AVAILABILITY ACT - APPENDIX
19D
Examination Determine whether the credit union’s funds availability policy and
0bjective procedures meet the requirements of the regulation
Categories implement the necessary controls to comply with the Expedited
Funds Availability Act; and
penalties as a result of failure to comply with the Expedited Funds
Availability Act.
Overview Regulation CC implements the requirements of the Expedited Funds

Availability Act. The purpose of the regulation is to ensure prompt
availability of funds and to expedite the return of checks.
The major provisions of Regulation CC include:
0 Establishing maximum holds that credit unions can place on

deposits; and.
0 Requiring credit unions to disclose their funds availability policies
to members.
In general, deposited funds fall into one of three categories of

availability.
Next-Day Credit unions should make certain types of funds available for
Ava ilabiIity withdrawal not later than the business day after the banking day the
funds were deposited. The following types of funds generally meet the
standards for next-day availability:
0 Cash deposits made in person to an employee of the credit union;

0 Electronic payments;
0 Checks drawn on the Treasury of the United States or a state or
local government;
Page 19D-1
EXAMINER’S GUIDE
0 U.S. Postal Service money order;

0 Cashier’s, certified, or teller’s check.
Check drawn on a Federal Reserve Bank or Federal Home Loan
Bank; and
Checks deposited in a branch of the credit union and drawn on the
same or another branch of the same credit union if both branches
are located in the same state or the same check-processing region.
In most cases, the types of funds listed above must be deposited in

person to an employee of the credit union and in an account of the
payee.
Second Day A credit union must make funds deposited in an account by check
Ava ilabiIity available for withdrawal not later than the second business day
following the banking day the funds are deposited, in the case of
A local check;
0 A check drawn on the Treasury of the United States that is not
governed by the next-day availability requirements;
0 A U.S. Postal Service money order that is not governed by the
next-day availability requirements; or
0 A check drawn on a Federal Reserve Bank or Federal Home Loan
Bank; a check drawn by a state or unit of general local government;
or a cashier’s, certified, or teller’s check; if any check referred to is
a local check that is not governed by the next-day availability
requirements.
Fifth Day A credit union must make funds deposited in an account by a check
Ava ilabiIity available for withdrawal not later than the fifth business day following
the banking day funds are deposited, in the case of
0 A nonlocal check; and

A check drawn on a Federal Reserve Bank or Federal Home Loan
Bank; a check drawn by a state or unit of general local government;
or a cashier’s, certified, or teller’s check; or a check deposited in a
branch of the depository credit union and drawn on the same or
another branch of the same credit union; if any check referred to is
Page 19D-2
EXPEDITED FUNDS AVAILABILITY ACT - APPENDIX 19D
a nonlocal check that is not governed by the next-day availability

requirements.
Credit unions must make available for withdrawal by cash or check

funds deposited in an account at a nonproprietary ATM not later than
the fifth business day following the banking day the funds are
deposited.
Exceptions Exceptions to the availability schedule apply in the case of:
0 New accounts;
0 Large deposits ($5,000 or greater);
0 Redeposited checks;
0 Repeated overdrafts;
0 Reasonable cause to doubt collectibility; and,
0 Emergency conditions.
DiscIosure A credit union shall make disclosures clearly and conspicuously in

Requirements writing. Disclosures, other than those posted at locations where
employees accept consumer deposits and ATMs and the notice on
preprinted deposit slips, must be a form that the member may keep.
The disclosures must be grouped together and must not contain any
information not related to the disclosures. If contained in a document
that sets forth other account terms, the disclosures must be highlighted
within the document.
Examination An examiner may perform the following examination procedures,

Procedures depending on the scope of the review.
0 Review the credit union‘s funds availability policy and procedures;

0 Review the credit union’s funds availability policy disclosures and
exception notices;
0 Determine the extent and adequacy of the instruction and training
provided to the individuals responsible for the implementation of
the credit union’s funds availability policy and procedures and
whether it adequately enables them to carry out their assigned
responsibilities in conformance with Regulation CC; and
Page 19D-3
EXAMINER'S GUIDE
0 Verify that the credit union provides employees with a written

statement regarding the procedures that pertain to that employee's
function.
Add itional Additional information is available on the Federal Reserve Board's

Information website at w.federalreserve.gov.
Page 19D-4
CHILDREN’S ONLINE PRIVACY PROTECTION ACT -
APPENDIX 19E
Examination 0 Determine whether the credit union’s website collects personal
0bjectives information from children under 13
0 Determine whether the credit union discloses its privacy notice and
obtains verifiable parental consent
Risk The following risk categories apply to the compliance area:

Categories
0 Compliance risk can occur when the credit union fails to
implement the necessary controls to comply with COPPA; and
0 Reputation risk can occur when the credit union incurs fines or
damaging publicity as a result of failure to comply with COPPA.
Overview The Children’s Online Privacy Protection Act (COPPA) applies to the
online collection of personal information from children under age 1 3.
The rule spells out what a website operator must include in a privacy
policy, when and how to seek verifiable consent from a parent, and
what responsibilities an operator has to protect children’s privacy and
safety online.
Credit unions who operate a commercial website or an online service

directed to children under 13 that collects personal information from
children must comply with COPPA. A credit union must also comply
if it operates a general audience website and has actual knowledge that
it is collecting personal information from children.
PersonaI COPPA applies to individually identifiable information about a child

Information that is collected online, such as full name, home address, email
address, telephone number or any other information that would allow
someone to identify or contact a child. COPPA also covers other types
of information (e.g., hobbies, interests and information collected
through cookies or other types of tracking mechanisms) when it is tied
to individually identifiable information.
Page 19E-1
EXAMINER’S GUIDE
Basic COPPA If the credit union is subject to the requirements of COPPA, a link to
Provisions its privacy notice must appear on the home page of its website or
online service and at each area where it collects personal information
from children. If the credit union operates a general audience site with
a separate children’s area, it must post a clear and prominent link to its
privacy notice on the home page of the children’s area. Credit unions
may wish to emphasize the link by using a larger font size or a
different color type on a contrasting background.
Privacy Notice COPPA requires a clearly written and understandable privacy notice
that includes the following information:
Name and contact information of the credit union;

Types of personal information collected from children and the
procedures used for collecting the information;
How the credit union uses the personal information;
Whether the credit union discloses the information to third parties;
Notification that the parent has the option to agree to the collection
and use of the child’s information without consenting to its
disclosure to third parties;
Notification that the credit union may not require a child to
disclose more information than is reasonably necessary to
participate in an activity as a condition of participation; and
Notification that the parent can review the child’s personal
information, ask to have it deleted, and refuse to allow any further
collection or use of the child’s information. The notice also must
state the procedures for the parent to follow.
Notice to The notice to parents must contain the same information included on
Parents the notice on the website. The credit union must notify a parent that it
wishes to collect personal information from the child. The notice must
also state that the parent’s consent is required for the collection, use,
and disclosure of the information and how the parent can provide
consent. The credit union must obtain verifiable consent, meaning that
the credit union must make reasonable efforts to ensure that the parent
receives the notice and consents. The required method of consent
depends on the use of the child’s information.
Page 19E-2
CHILDRENS ONLINE PRIVACY PROTECTION ACT-APPENDIX 19E

Procedures depending on the scope of the review:
0 Review the credit union’s privacy notice to determine whether it

contains the information required by COPPA;
0 Review the notice to parents and determine how the credit union
obtains verifiable consent; and
0 Review the credit union’s procedures and internal controls for
maintaining and disclosing personal information collected from
children under 13.
Add itionaI Additional information is available on the Federal Trade

Information Commission’s (FTC) website at www.ftc.Pov/kidzprivacy or through
the FTC’s Consumer Response Center at 1-877-FTC-HELP.
Page 19E-3
ELECTRONIC FUNDS TRANSFER ACT - APPENDIX
19F
Examination 0 Determine that the credit union has procedures in place to ensure
Objectives compliance with the Electronic Funds Transfers Act (EFTA)
0 Determine that the credit union complies with the provisions of the
EFTA
Category implement the necessary controls to comply with the EFTA.
Overview Regulation E implements the provisions of the EFTA. The regulation

establishes the basic rights, liabilities, and responsibilities of
consumers who use electronic fund transfer services and of credit
unions that offer these services. The primary objective of the
regulation is the protection of individual consumers engaging in
electronic fund transfers.
The term electronic fund transfer means any transfer of funds initiated
through an electronic terminal, telephone, computer, or magnetic tape
for the purpose of ordering, instructing, or authorizing a credit union to
debit or credit an account. The term includes, but is not limited to:
0 Point-of-sale transfers;
0 Automated teller machine transfers;
0 Direct deposits or withdrawals of funds;
0 Transfers initiated by telephone; and
0 Transfers resulting from debit card transactions, whether or not
they were initiated through an electronic terminal.
The term electronic fund transfer does not include:
0 Checks. Any transfer of h d s originated by check, draft, or similar

paper instrument; or any payment made by check, draft, or similar
paper instrument at an electronic terminal;
Page 19F-1
EXAMINER’S GUIDE
0 Wire or other similar transfers. Any transfer of funds through

Fedwire or through a similar wire transfer system used primarily
for transfers between financial institutions or between businesses;
0 Automatic transfers by account-holding institution. Any transfer of
funds under an agreement between a consumer and a financial
institution which provides that the institution will initiate
individual transfers without a specific request from the consumer;
or
0 Telephone-initiated transfers. Any transfer of funds initiated by a
telephone communication between a consumer and a financial
institution making the transfer; and does not take place under a
telephone bill-payment or other written plan in which periodic or
recurring transfers are contemplated.
Access An access device is a card, code, or other means of access to a

Devices member’s account, or any combination thereof, which the member
may use to initiate electronic fund transfers.
A credit union may issue a solicited access device:
0 In response to an oral or written request for the device; or

0 As a renewal of, or in substitution for, an accepted access device
whether issued by the institution or a successor.
A credit union may only issue an unsolicited access device if it is:
0 Not validated, meaning that the credit union has not yet performed
all the procedures that would enable a member to initiate an
electronic fund transfer using the access device;
0 Accompanied by a clear explanation that the access device is not
validated and provides information as to how members may
dispose of it if they do not desire to validate the device;
0 Accompanied by the disclosures of the member’s rights and
liabilities that will apply if the access device is validated; and
0 Validated only in response to the member’s oral or written request
for validation, after the institution has verified the member’s
identity by a reasonable means.
Page 19F-2
ELECTRONIC FUNDS TRANSFER ACT - APPENDIX 19F
Disclosures Regulation E requires credit unions to provide members with an initial

disclosure at the time the member contracts for an electronic fimd
transfer service or before making the first electronic fund transfer
involving the member’s account. The disclosure must contain the
following information:
a Liability of the member;

a Telephone number and address of the office to be notified in the
case of an unauthorized electronic fimd transfer;
a Business days;
a Types of transfers and limitations;
a Fees;
a Summary of the member’s right to receipts and periodic
statements;
a Stop payment rights;
a Liability of the credit union;
a Circumstances in which the credit union may provide information
about the member’s account to third parties;
a Error resolution; and
a ATM fees.
If adverse changes in fees, the member’s liability, types of transfers

available, or limits on transfers occur, the credit union must provide a
change-in-terms notice at least 21 days before the changes take effect.
The credit union must periodically send a reminder of the error-
resolution procedures. It may send a detailed notice annually or
provide an abbreviated notice with each account statement.
Members must receive a receipt when they initiate an electronic

transfer, and documentation monthly in the form of periodic
statements. Both documents must include the type of electronic
transfer, the amount and date of the transaction, and the location of the
terminal.
Liability for A member’s liability for unauthorized electronic fimd transfers, such as
Unauthorized those arising from loss or theft of an access device, is limited to $50 if
Transfers notice is given within two business days after learning of the theft or
loss. If the member fails to notify the credit union within the
Page 19F-3
EXAMINER’S GUIDE
established time frames, the amount of liability shall not exceed the
lesser of $500 or the sum of:
$50 or the amount of unauthorized transfers that occur within the

two business days, whichever is less; and
The amount of unauthorized transfers that occur after the close of
two business days and before notice to the credit union, provided
the credit union establishes that these transfers would not have
occurred had the member notified the credit union within that two-
day period.

Review the credit union’s policy and procedures for complying

with Regulation E;
Review the credit union’s Electronic Funds Transfer disclosures;
Review policies regarding liability for unauthorized transfers;
Review policies regarding issuance of access devices; and
Perform tests on transactions to determine whether the credit union
has implemented the above policy and procedures.
Additional Additional information is available on the Federal Reserve Board’s

Information website at www.federalreserve.gov.
Page 19F-4
E-SIGN ACT - APPENDIX 19G
Examination 0 Determine whether the credit union complies with the E-Sign Act
Objective when accepting electronic signatures and using electronic
disclosures
Categories implement the necessary controls to comply with the E-Sign Act.
E-Sign Act The E-Sign Act provides for facilitating the use of electronic records
and signatures in commerce. The general rule of the E-Sign Act allows
a signature, contract, or other record to be considered valid in an
electronic format. To comply with the E-Sign Act, an electronic
signature must be executed or adopted by a member with the intent to
sign the record. Accordingly, regardless of the technology used to meet
this requirement, the process must evidence the member’s identity.
The following terms apply to the E-Sign Act:
Electronic: relating to technology having electrical, digital, magnetic, wireless,

optical, electromagnetic, or similar capabilities.
Electronic Record: a contract or other record created, generated sent,

communicated, received, or stored by electronic means.
Electronic Signature: an electronic sound, symbol, or process, attached to or

logically associated with a contract or other record and executed or adopted by a
person with the intent to sign the record.
Electronic The E-Sign Act permits credit unions to provide disclosures to

Disclosures members in an electronic format. The E-Sign Act does not affect the
content or timing of any required disclosure.
Under the E-Sign Act, members must consent electronically or confirm

their consent electronically, in order to demonstrate that they can
access the information in the electronic format being used. Prior to
consenting the credit union must provide the member with a clear and
conspicuous statement informing the member of:
Page 196-1
EXAMINER'S GUIDE
The option to receive the document in paper form;

0 The scope of the consent (single transaction or ongoing
relationship);
0 The right to withdraw consent to electronic disclosures and any
consequences (fees or termination of account, for example);
0 Hardware and software requirements (if these change and there is a
material risk that consumers may not be able to access information,
credit unions must provide notice of the changes and a right to
withdraw consent); and
0 The method to request and obtain a paper copy of an electronic
record and any associated fee.
Delivery of A credit union that uses electronic communication to provide

Disclosures disclosures may send the disclosures to the member's designated
electronic address (e-mail) or make them available at another location,
such as the credit union's website. If the credit union makes the
disclosure available at such a location, it effectively delivers the
disclosure by sending a notice alerting the member when the member
can access the disclosure and making the disclosure available for at
least 90 days.
If an electronic disclosure is returned undelivered, the credit union

must take reasonable steps to attempt redelivery (either electronically
or to a postal address) based on information in the credit union's own
files.
A credit union's inability to deliver a disclosure does not affect the

timeliness of the disclosure, as long as the disclosure is initially sent in
a time appropriate manner.
Record The E-Sign Act provides for meeting statutory record retention
Retention requirements by retaining an electronic record. The electronic record
must accurately reflect the information set forth in the record and
remain accessible to all persons who are entitled to it in a form that is
capable of being accurately reproduced for later reference. An
electronic record of the information on the front and back of the check
satisfies the requirements for retention of checks.
Page 196-2
E-SIGN ACT - APPENDIX G
Examination Determine if the credit union has an informational or transactional

Procedures web site;
0 Determine if the credit union distributes required disclosures in an
electronic format;
0 Determine whether appropriate disclosures were provided to
members for each product or service before completing the
transaction; and
0 Determine that disclosures are clear and conspicuous, provided in a
form the consumer may retain and refer to, and consistent with
model disclosure forms.
Page 196-3
FAIR CREDIT REPORTING ACT -APPENDIX 19H
Examination Determine whether the credit union meets the requirements of the
Objectives Fair Credit Reporting Act (FCRA) when it takes adverse action
based, in whole or in part, on information obtained from outside
sources; and
0 Determine whether the credit union acts as a Consumer Reporting
Agency (CRA), and if so, whether it complies with the CRA
requirements of the FCRA.
Categories implement the necessary controls to comply with FCRA; and
penalties as a result of failure to comply with FCRA.
Overview The FCRA defines the responsibilities and liabilities of those who
provide information to and access data from a Consumer Reporting
Agency (CRA). The FCRA was designed to promote accuracy,
fairness, and privacy of information in the files of every CRA by:
0 Regulating the consumer reporting industry;

0 Placing disclosure obligations on users of consumer reports;
0 Ensuring fair, timely, and accurate reporting of credit information;
0 Restricting the use of reports on consumers; and
0 In certain situations, requiring the deletion of obsolete information.
Consumer A consumer report means any written, oral or other communication of

Report any information by a CRA bearing on a consumer’s credit worthiness,
credit standing, credit capacity, character, general reputation, personal
characteristics, or mode of living which is used or expected to be used
or collected in whole or in part for the purpose of serving as a factor in
establishing the consumer’s eligibility for:
0 Credit or insurance primarily used for personal, family, or

household purposes;
Page 19H-1
EXAMINER'S GUIDE
Employment purposes; or
0 Any other purpose specifically stated in $604 of the FCRA.
The term credit report does not mean a report containing information
solely about transactions or experiences between the consumer and the
credit union.
Consumer A CRA is any person which, for monetary fees, dues, or on a

Reporting cooperative nonprofit basis, regularly engages in whole or in part in the
Agency practice of assembling or evaluating consumer credit information or
other information on consumers for the purpose of furnishing
consumer reports to third parties, and which uses any means or facility
of interstate commerce for the purpose of preparing or furnishing
consumer reports.
The FCRA contains additional requirements for organizations which

function as a CRA, in addition to the requirements imposed on users
and organizations reporting information to a CRA.
Compliance The FCRA applies to creditors, employers, landlords, and other

with the businesses that exchange consumer information with CRAs, including
FCRA institutions that offer checking or share draft accounts.
The FCRA also affects lenders extending credit to an individual for

business purposes or to a closely held business. When an individual is
or will be personally liable for repayment of a loan for business
purposes, such as an individual proprietor, co-signer, or guarantor, the
loan is a consumer transaction.
Credit Union When one credit union provides another credit union or a CRA
Consumer information about a member reported to it by another person or
Reporting organization, the credit union is considered a CRA. It must comply
Agency with all the sections of the FCRA relating to CRAs concerning that
member.
When a credit union provides information based solely on its own

transactions with the member to another credit union or to a CRA, it is
Page 19H-2
FAIR CREDIT REPORTING ACT - APPENDIX 19H
not acting as a CRA. Similarly, if the credit union furnishes

information from outside sources to another party involved in the same
transaction, the credit union is not a CRA. Such parties could include
an insurer or a guarantor (as in the case of FHA, VA, private insurers
or insured student loan programs), other financial institutions
participating in the transaction, or a collection agency engaged in the
collection of the transaction.
Using Users of consumer reports must identify themselves to the CRA and
Consumer certify that they will use the information they request as specified in
Reports the FCRA and will not use the information for any other purpose.
If the credit union takes any adverse action with respect to any member
that is based in whole or in part on any information contained in a
consumer report, the credit union must
0 Provide oral, written, or electronic notice of the adverse action to

the member;
0 Provide to the member orally, in writing, or electronically:
- The name, address, and telephone number of the consumer

reporting agency (including a toll-free telephone number
established by the agency if the agency compiles and maintains
files on consumers on a nationwide basis) that furnished the
report to the person; and
- A statement that the consumer reporting agency did not make
the decision to take the adverse action and cannot provide the
member the specific reasons why the adverse action was taken;
and
0 Provide to the consumer an oral, written, or electronic notice of the

consumer's right:
- To obtain a free copy of a consumer report on the member from

the consumer reporting agency;
- To dispute with the consumer reporting agency the accuracy or
completeness of any information in the consumer report
h i s h e d by the agency.
Page 19H-3
EXAMINER'S GUIDE
To do this, the credit union must supply a standard disclosure form that
provides the member with information to gain access to the consumer
report and make corrections, if necessary.
Information If adverse action occurs on the basis of information obtained from a

from Other source other than a CRA, the credit union must disclose the applicant's
Sources right to file a written request for the nature of the information within
60 days of learning of the adverse action.
If a member requests it, the credit union must then disclose the nature
of the information to the consumer, orally or in writing, in sufficient
detail to enable the consumer to evaluate its accuracy. The credit union
may disclose the source of the information, but is not required to do so.
Information in If a credit union takes adverse action because of information it has in

Credit Union its own files (which it has not obtained from outside sources) or on
Files information given to it by the member, the credit union is not required
to disclose the nature of the information on which the credit union
based the denial of credit. However, most credit unions do give
members this information as a matter of courtesy and to counsel them
in resolving their financial problems.
(The disclosure forms developed for notifying applicants of adverse

actions under Regulation B indicate that the credit union meets FCRA
disclosure requirements.)
Documenting Credit unions may disclose orally the information required under the
Compliance FCRA. However, if the action resulting in a denial of credit under the
FCRA also meets the definition of adverse action under Regulation B,
the credit union must make additional disclosures to the consumer.
Although the credit union may provide the required disclosures for
both the FCRA and Regulation B on the same disclosure form, they are
independent and one cannot substitute for the other. To meet the
requirements of both the FCRA and Regulation B, credit unions may
wish to use form letters, copies of which may be kept in files with the
Page 19H-4
FAIR CREDIT REPORTING ACT - APPENDIX 19H
completed application forms. This practice allows internal monitoring

of compliance and provides evidence in the event of litigation.
Providing Anyone who furnishes information to a CRA:

Consumer
Information 0 May not furnish information that it knows (or consciously avoids
knowing) is inaccurate;
0 Must notify CRAs when members voluntarily close credit
accounts. This is important because some users may interpret a
closed account as an indicator of bad credit unless it is clearly
disclosed that the consumer, not the creditor, closed the account;
0 Must noti@ the CRA within 90 days after reporting information
about a delinquent account placed for collection, charged to profit
or loss, or subject to any similar action, of the month and year the
delinquency commenced that triggered reporting. It is important to
note the correct date the delinquency commenced to compute how
long derogatory information can be kept in a member's file; and
0 Must correct incomplete or inaccurate information, resubmit it to
each CRA, and report only the correct information in the future.
Once a credit union is notified that a member disputes information it

provided on the consumer report, the credit union:
0 May not give that information to any CRA without also telling the
CRA that the information is in dispute;
0 Must investigate the dispute and review all relevant information
provided by the CRA about the dispute; and
0 Must report its findings to the CRA involved and all national
CRAs that received the information if the investigation shows the
information to be incomplete or inaccurate.
The credit union should resolve the dispute within 30 days after receipt
of a dispute notice from the member. If the member provides
additional relevant information during the 30-day period, the CRA has
an additional 15 days to complete the investigation. The CRA must
give the credit union all relevant information that it gets within five
business days of receipt and must promptly give additional relevant
information provided by the member. If a credit union does not
Page 19H-5
EXAMINER'S GUIDE
investigate and respond within the specified time periods, the CRA
must delete the disputed information from its files.
Penalties and Credit unions may be liable for willful noncompliance or negligent
LiabiIit ies noncompliance as either users of information or as CRAs. Liability
may include actual damages, punitive damages, court costs, and
attorney's fees, depending on the type of noncompliance. If a credit
union obtains a credit report under false pretenses it may receive a
penalty of $1,000 or actual damages, whichever is greater.

Determine whether the credit union uses consumer reports or other

outside information in evaluating credit applications.
0 Review an adequate sample of rejected loan files to determine if
the adverse action notice appropriately discloses the CRA
information, if the credit denial was based on information it
obtained from the CRA.
0 Determine whether the credit union has procedures in place to
provide consumers (upon request) the nature of the "other" outside
information; and
0 If the credit union is a CRA, determine whether it:
- Provides required disclosures to consumers;

- Does not report obsolete information;
- Resolves accuracy disputes with the consumer;
- Provides reports for only legitimate purposes;
- Maintains proper records on each recipient of the information
about the consumer;
- Adequately trains personnel in the furnishing of information;
and,
- Maintains procedures to ensure maximum possible accuracy of
information received, recorded, and reproduced.
Add itional For more information, call the FTC toll-free at 1-877-FTC-HELP (1-
Information 877-382-4357), or go to http://www.FTC.nov.
Page 19H-6
FAIR DEBT COLLECTION PRACTICES ACT
APPENDIX I 9 I
Examination Determine whether the credit union is subject to the Fair Debt
Objectives Collection Practices Act (FDCPA) by collecting consumer debts on
behalf of another party
Determine whether the credit union has procedures in place to
comply with the FDCPA
Categories implement the necessary controls to comply with FDCRA; and
penalties as a result of failure to comply with FDCRA.
Overview The purpose of the FDCPA is (1) to eliminate abusive debt collection
practices by debt collectors, (2) to ensure that those debt collectors
who refrain from using abusive practices are not competitively
disadvantaged, and (3) to promote consistent state action to protect
consumers against debt collection abuses.
A credit union is considered a “debt collector” and is subject to the

FDCPA only if it regularly collects consumer debts on behalf of
another party, with some exceptions. If the credit union merely collects
its own debts, in its own name, compliance with the FDCPA is not
required. However, the credit union should avoid those practices
prohibited under the FDCPA.
Prohibited Harassment or Abuse. A debt collector may not engage in any

Practices conduct the natural consequence of which is to harass, oppress, or
abuse any person in connection with the collection of a debt. The
following conduct is a violation of this section:
0 Use or threat of use of violence or other criminal means to harm

the physical person, reputation, or property of any person;
0 Use of obscene or profane language;
Page 19 1-1
EXAMINER'S GUIDE
Publication of a list of consumers who allegedly refuse to pay

debts;
Advertisement for sale of any debt to coerce payment of the debt;
or,
Causing a telephone to ring or engaging any person in telephone
conversation repeatedly or continuously with the intent to annoy,
abuse, or harass any person at the called number.
False or Misleading Representations. A debt collector may not use

any false, deceptive, or misleading representation or means in
connection with the collection of any debt. Violations of this section
include:
The false representation of the character, amount, or legal status of

any debt;
0 The false representation or implication that any individual is an
attorney or that any communication is from an attorney;
0 The threat to take any action that cannot legally be taken or that is
not intended to be taken; or,
Communicating or threatening to communicate to any person
credit information that is known to be false, including failure to
communicate that a disputed debt is disputed.
Unfair Practices. A debt collector may not use unfair or

unconscionable means to collect or attempt to collect any debt such as:
0 Collecting interest, fees, charges, or expenses incidental to the

principal obligation unless it is expressly authorized by the
agreement;
0 Depositing or threatening to deposit any postdated check prior to
the date on the check; or,
0 Causing charges to be made to any person for communications by
the concealment of the true purpose of the communication, such as
a collect telephone call.
Validation of A debt collector must send the consumer a written notice within five
Debts days after the initial communication unless the following information
is contained in the initial communication or the consumer has paid the
debt:
Page 19 1-2
FAIR DEBT COLLECTION PRACTICES ACT - APPENDIX 19 I
0 Amount of the debt;

Name of the creditor to whom the debt is owed;
A statement that the consumer must dispute the validity of the
debt, or any portion thereof, within thirty days of receiving the
notice, or the debt will be assumed to be valid by the debt
collector;
0 A statement that if the consumer disputes the debt in writing, the
debt collector will obtain verification of the debt or a copy of a
judgment against the consumer and mail it to the consumer; and,
0 A statement that, upon the consumer’s written request within thirty
days, the debt collector will provide the name and address of the
original creditor, if different from the current creditor.
Enforcement The National Credit Union Administration is responsible for

enforcement for federal credit unions, while the Federal Trade
Commission (FTC) enforces the FDCPA for state-chartered credit
unions. Any debt collector who fails to comply with any provision of
the FDCPA is liable in an amount equal to the sum of any actual
damage sustained by such person. Additional damages may be
recovered, not to exceed $1,000 for an individual plaintiff or named
plaintiff in a class action suit, or $500,000 or 1 percent of net worth for
all other class members.

Determine if the credit union meets the definition of a debt

collector under the FDCPA;
Determine if appropriate policies and procedures are in place to
comply with the FDCPA; and,
Review collection practices and procedures to determine if the
credit union uses any of the prohibited practices while acting as a
debt collector.
Additional Adtional information about the FDCPA is available on the FTC’s

Information website at www.ftc.gov.
Page 19 1-3
1qz-4 w
FAIR HOUSING ACT - APPENDIX 19J
Examination Determine that the credit union evaluates each loan applicant's
Objectives creditworthiness on an individual basis, without presuming the
applicant has characteristics of a certain group
0 Determine if the credit union's loan policies or procedures limit the
inflow of applications from protected classes (pre-screening)
Determine if the credit union rejects applications from any of the
groups with a disproportionate frequency, or if its acceptance
levels are disproportionately lower for one or more groups due to
such factors as withdrawals or delays
Determine whether the credit union has adequate economic
justification for any policies or practices that have a
disproportionately negative effect based on applicants' ages
Determine if the credit union's lending patterns reflect more
stringent loan terms (interest rate, loan maturity, loan-to-value
ratio, etc.) for affected groups
0 Determine whether the credit union provides reasons for the
rejections (or other less than favorable actions) consistent with the
credit union's underwriting criteria and whether the credit union
uniformly applies them to all applicants and all areas
Categories implement the necessary controls to comply with the Fair Housing
Act (FHA); and
penalties as a result of failure to comply with the FHA.
Overview The Fair Housing Act (FHA) provides fair housing throughout the
United States by regulating many practices relating to housing. In
particular, FHA makes it unlawful for any lender to discriminate in its
housing-related lending activities against any person because of race,
color, religion, national origin, sex, handicap, or familial status.
The FHA works in conjunction with the Equal Credit Opportunity Act
(ECOA) to prohibit discrimination on any of the prohibited bases by
anyone who is in the business of providing loans for housing. NCUA
Page 195-1
EXAMINER'S GUIDE
Rules and Regulations 5701.3 1 summarizes the prohibitions on

discrimination in real estate lending activities contained in the FHA
and ECOA.
Non- A credit union may not deny a loan or other financial assistance for the
Discrimin- purpose of purchasing, constructing, improving, repairing, or
ation in maintaining a dwelling, nor may it discourage an application for such a
Lending loan, on the basis of the race, color, religion, handicap, familial status
(having children under the age of 1S), national origin, or sex of:
0 The loan applicant or joint applicant;

0 Any person associated with the loan applicant or joint applicant;
0 The present or prospective owners, lessees, tenants, or occupants of
other dwellings in the vicinity of the dwelling.
It is unlawful to discriminate because of race, color, religion, handicap,

familial status, national origin, or sex in determining the:
0 Amount;
0 Interest rate;
0 Duration; or
0 Other credit terms.
The FHA prohibits the lender from considering the following factors
because they are not necessary to a federal credit union's business and
they generally have a discriminatory effect:
Age or location of the dwelling;

Zip code of the applicant's current residence;
0 Previous home ownership;
0 Age or location of dwellings in the neighborhood of the subject
dwelling; or
0 Income level of residents in the neighborhood of the dwelling.
A credit union may not rely on an appraisal that it knows or should

know is based upon any prohibited bases or factors listed above.
Page 195-2
Legal Because the FHA was broadly written by Congress, the courts have
Interpretations ruled a wide variety of lending practices illegal under the Act,
including some that the Act itself does not specifically mention but
which the courts determined are illegal because they violate implicit
requirements and prohibitions. Examples of some prohibited practices
include:
Redlining on a racial basis. "Redlining" is the practice of denying

loans for housing in certain neighborhoods even though the
individual applicant may otherwise qualifL for credit;
Making excessively low appraisals in relation to purchase prices,
based on prohibited considerations (closely akin to redlining);
Discouraging applications for credit on prohibited bases, as well as
outright denials. Taken together, the FHA and ECOA produce a
strong statutory prohibition against prescreening or discouraging
applicants by housing sellers or lenders, even to the point of
ensuring that their advertising policies do not have that effect;
The use of excessively burdensome qualification standards for the
purpose, or with the effect, of denying housing to protected
applicants;
Applying differing standards or procedures in administering
foreclosures, late charges, penalties, or reinstatements, or other
collection procedures;
Racial notation or code on appraisal forms or loan forms (other
than the information which 5202.13 of Regulation B requires the
credit union to retain for monitoring purposes);
Use by initial interview personnel of scripts designed to discourage
protected applications; and
Patterns of significantly greater or exclusive use of insured or
guaranteed loan programs by protected groups or in certain areas.
This may indicate illegal "steering" to this type of lending by the
credit union.
Advertising Credit unions may not directly or indirectly engage in any form of
advertising of real estate related loans that implies or suggests the
credit union discriminates.
Any credit union that advertises real estate related loans must
prominently indicate in the advertisement, in a manner appropriate to
Page 195-3
EXAMINER'S GUIDE
the advertising medium and format used, that it makes such loans
without regard to the prohibited bases. In addition, every credit union
engaged in real estate lending must provide a notice of
nondiscrimination in its lobby. The notice must be clearly visible to the
general public and must contain the logotype and language appearing
in the FHA or NCUA Rules and ReguZutions §701.31(d)(3).
Enforcement Persons who claim they were victims of discrimination may file a
complaint with the United States Department of Housing and Urban
Development (HUD) for processing under the FHA. HUD will
investigate the complaint and may attempt to resolve the grievance
through conference, conciliation, and persuasion. It is unlawful to
coerce, intimidate, threaten, or interfere with any person in the exercise
of, or because they have exercised, rights granted by certain sections of
FHA.
Persons who believe they were discriminated against may also file a
compliant with NCUA for processing under NCUA Regulations.

0 Determine that the board has adopted policies, procedures, and

general underwriting standards concerning nondiscrimination in
lending;
0 Determine that the officials review loan underwriting standards and
related business practices regularly;
0 Determine by reviewing rejected mortgage loan applications if the
credit union engages in prohibited practices;
0 Determine from the credit union's practices, records, and reports
that it refrains from setting more stringent terms (down payments,
interest rates, terms, fees, loan amounts, etc.) for housing-related
loans in certain geographic areas located reasonably within its
operational area. If the credit union imposes more stringent terms,
determine from a review of loans in these areas whether the credit
union used more stringent standards solely for documented
economic reasons;
Page 195-4
Determine that the credit union does not discriminate on the basis
of the racial composition or the income level of an area;
Determine that the credit union does not discriminate on the basis
of the language of applicants;
Determine that the credit union has not set an arbitrary limit on
loan size and the income required before granting a loan;
Determine that the credit union refrains from using appraisals that
discriminate;
Determine that the credit union refrains from discounting appraised
values (i.e., lowering the appraised value of property because of
location or some negative comment in the appraisal form);
Determine from reviewing approved and rejected loan applications
that the credit union documents uniformly applied economic
factors, such as (1) income and debt ratios, (2) credit history, (3)
security property, (4) neighborhood amenities, and ( 5 ) personal
assets;
Determine from the loan review whether the credit union makes a
disproportionate number of loans under one type of financing
(FHA, VA, other alternative mortgage instruments);
Based on a review of appropriate loan records, determine that the
credit union administers the following without bias: (1) loan
modifications, (2) loan assumptions, (3) additional collateral
requirements, (4) late charges, ( 5 ) reinstatement fees, and (6)
collections;
Determine that the credit union has policies that prohibit the
employees from making statements that would discourage the
receipt or consideration of any application for a loan or other credit
service;
Visually determine whether the credit union has an Equal Housing
Lender Poster located in a conspicuous place in all of the credit
union's offices;
Visually inspect the size and content of each nondiscrimination
notice, such as the Equal Housing Lender Poster, to ensure it is
clear and conspicuous and in compliance with the requirements of
$701.31(d)(3) of the NCUA Rules and Regulations;
Determine that a sampling of the credit union's advertising
complies with the requirements of $701.3l(d) of the NCUA Rules
and Regulations;
Page 19J-5
EXAMINER’S GUIDE
0 Determine that marketing practices ensure the availability of the

credit union’s services without discrimination to its field of
membership;
Complete the applicable FHA checklist in AIRES; and
Document a violation of the FHA on the Violations form in
AIRES.
Additional Please refer to $701-31(e) of the NCUA Rules and Regulations for
Information additional guidelines concerning nondiscrimination in lending. In
addition, information is available on HUD’s website at www.hud.gov.
Page 195-6
FLOOD DISASTER PROTECTION ACT - APPENDIX
I9K
Examination Determine whether a credit union performs required flood
Objectives determinations for loans secured by improved real estate or a
mobile home affixed to a permanent foundation in accordance with
the final rule
Determine if the credit union requires flood insurance in the correct
amount when it makes, increases, extends, or renews a loan
secured by improved real estate or a mobile home located, or to be
located, in a Special Flood Hazard Area (SFHA) of a community
participating in the National Flood Insurance Program (NFIP)
Determine if the credit union provides the required notices to the
borrower, servicer, and to the Director of the Federal Emergency
Management Agency (FEMA) whenever it requires flood
insurance as a condition of the loan
Determine if the credit union requires escrow accounts for flood
insurance premiums when requiring flood insurance on a
residential building and when other items required escrowing
Determine if the credit union complies with the forced placement
provisions if at any time during the term of a loan it determines
that flood insurance on the loan does not sufficiently meet the
requirements of the regulation
Categories implement the necessary controls to comply with Flood Disaster
Protection Act (FDPA); and
Reputation risk can occur when the credit union incurs fines,
penalties, or poor publicity as a result of failure to comply with
FDPA.
Overview The National Flood Insurance Program (NFIP) is a federal program

enabling property owners to purchase insurance protection against
losses from flooding. It provides an insurance alternative to disaster
assistance to meet the escalating costs of repairing damage to buildings
and their contents caused by floods. Flooding ranks as the most
Page 19K-1
EXAMINER’S GUIDE
common natural disaster, costing more in damages and loss of life than
any other disaster.
An agreement between local communities and the federal government

governs participation in the NFIP. The agreement states if a
community will adopt and enforce a floodplain management ordinance
to reduce future flood risks to new construction in SFHAs, the Federal
Government will make flood insurance available within the
community as a financial protection against flood losses.
If the property securing a member’s loan is located in a SFHA, but the

SFHA is in a community that does not participate in the NFIP, the
member will not have federal flood insurance available.
To obtain information on a community’s participation status, telephone

FEMA at 1-800-358-9616 or check FEMA’s web site at
http://www.fema.aovlfemdcsb.htm.
Flood Part 760 of the NCUA Rules and Regulations implements the
Disaster requirements of the National Flood Insurance Act of 1968 and the
Protection Flood Disaster Protection Act (FDPA) of 1973, as amended (42 U.S.C.
Act 4001-4129.) This part applies to loans secured by buildings or mobile
homes located or to be located in areas determined by the Director of
the FEMA to have special flood hazards.
Part 760 requires the following:
0 A credit union cannot make, increase, extend, or renew any loan

secured by a building or mobile home located or to be located in a
SFHA in which flood insurance is not available unless the
collateral securing the loan is covered by flood insurance for the
term of the loan;
0 The amount of the flood insurance must at least equal the lesser of
the outstanding principal balance of the designated loan or the
maximum limit of coverage available for the particular type of
property under the Act; and
Page 19K-2
FLOOD DISASTER PROTECTION ACT - APPENDIX 19K
0 Flood insurance coverage is limited to the overall value of the

property securing the loan minus the value of the land on which the
property is located.
Exemptions The flood insurance requirement does not apply with respect to:
0 Loans on state-owned property covered under an adequate policy

of self-insurance satisfactory to the Director of FEMA; or
0 Loans with an original principal balance of $5,000 or less a
repayment term of one year or less.
Eligible The following types of structures are eligible for flood insurance
Str uctures coverage:
0 Residential, industrial, commercial, and agricultural buildings that

are walled and roofed structures that are principally above ground;
0 Buildings under construction where a development loan is made to
construct improvements on the land. Insurance can be purchased to
keep pace with the new construction;
0 Mobile homes that are affixed to a permanent site, including
mobile homes that are part of a dealer’s inventory and affixed to
permanent foundations;
0 Condominiums; or
0 Co-operative buildings.
Members may also obtain flood insurance coverage for personal

property and other insurable contents contained in real property or
mobile homes located in SFHAs. The real property must be insured in
order for the contents to be eligible.
Second Both second mortgages and home equity loans are transactions that
Mortgages and come within the purchase provisions of the FDPA. Since only one
HELOCs flood insurance policy can be issued for a building, a credit union
should not request a new flood insurance policy if one already exists.
Instead, the credit union should have the borrower contact the
insurance agent to:
Page 19K-3
EXAMINER'S GUIDE
0 Inform the agent of the intention to obtain a loan involving a

subordinate lien;
0 Obtain verification of the existence of a flood insurance policy; and
0 Check that the insurance sufficiently covers all loan amounts.
After obtaining this information, the insurance agent should increase

the amount of coverage if necessary and issue an endorsement that will
reflect the credit union as a lien holder.
For loans with approved lines of credit that members may access in the
future, credit unions may have difficulty calculating the amount of
insurance for the loan since the borrower will be drawing down
differing amounts on the line at different times. In those instances the
borrower must, at a minimum, obtain a policy as a requirement for
drawing on the line.
As a matter of administrative convenience to ensure compliance with

the requirements, a credit union may take the following alternative
approaches:
Review its records periodically so that as the member draws

against the line, the appropriate amount of insurance coverage can
be maintained; or
0 Require the purchase of flood insurance for the total amount of the
loan, or the maximum amount of flood insurance coverage
available, whichever is less.
Lending in Non- Flood insurance coverage is an important component of prudent

participating underwriting for credit unions that extend loans in at-risk areas, to
Communities maintain safety and soundness and protect the lender's interest in its
collateral. Credit unions with significant lending in nonparticipating
communities should take care to ensure that the risks associated with
loans secured by properties in flood hazard areas where flood
insurance is not available are monitored and controlled.
Page 19K-4
Standard A credit union must use the standard flood hazard determination form
Flood Hazard developed by FEMA when determining whether the building or mobile
Determin- home offered as collateral security for a loan is or will be located in a
ation Form SFHA which has flood insurance. Credit unions may use the standard
flood hazard determination form in a printed, computerized or
electronic manner. The credit union must retain a copy of the
completed form, in either hard copy or electronic format, for the period
of time the credit union owns the loan.
Reliance on A credit union can rely on a prior SFHA determination if:

Prior
Determination The previous determination is not more than seven years old;
The basis for it was recorded on the standard flood hazard
determination form; or
The loan is a subsequent transaction by the same institution with
respect to the same property, i.e., assumption, refinancing, renewal,
or second lien loan. A new determination is not required, assuming
the other requirements are met.
A credit union may not rely on a previous determination if:
FEMA’s map revisions or updates show that the security property

is now located in an SFHA;
The lender discovers that map revisions or updates affecting the
security property were made after the date of the previous
determination; or
The loan is not a subsequent transaction by the same institution
with respect to the same property (e.g., a lender purchases a loan
from another lender.)
Determination Any credit union or a servicer acting on its behalf may charge a
Fees reasonable fee for determining whether the building or mobile home
securing the loan is located or will be located in a SFHA if the
determination:
Is made in connection with a making, increasing, extending, or

renewing of the loan that is initiated by the borrower;
Page 19K-5
EXAMINER’S GUIDE
0 Reflects a revision or updating of floodplain areas or flood-risk

zones by FEMA;
Is due to FEMA’s publication of a notice that affects the area in
which the loan is located; or
Results in the purchase of flood insurance coverage by the credit
union or its servicer on behalf of the borrower under the forced
placement provision.
A determination fee may also include, but is not limited to, a fee for
life-of-loan monitoring.
Required When a credit union makes, increases, extends, or renews a loan

Notices secured by a building or a mobile home located or to be located in a
SFHA, the credit union must mail or deliver a written notice to the
borrower and to the servicer, regardless of whether or not flood
insurance is available for the collateral securing the loan. The written
notice must include the following information:
0 A warning that the building or mobile home is or will be located in

a SFHA;
0 A description of the flood purchase requirements set forth in
Section 102(b) of the FDPA of 1973, as amended (42 U.S.C.
4012a(b));
0 A statement that flood insurance coverage is available under the
NFIP, and possibly from private insurers; and
0 A statement as to whether Federal disaster relief assistance may be
available in the event of damage to the building or mobile home,
caused by flooding in a Federally-declared disaster.
Delivery of Delivery of notice must take place within a “reasonable time” before
Notice the completion of the transaction. Ten days is generally regarded as a
“reasonable” time interval. A borrower should receive notice timely
enough to ensure that:
The borrower has the opportunity to become aware of the

borrower’s responsibilities under the NFIP; and
Where applicable, the borrower can purchase flood insurance
before completion of the loan transaction.
Page 19K-6
Notice to The servicer should receive notice as promptly as practicable after the
Servicers credit union provides notice to the borrower and no later than the time
the credit union provides similar notices to the servicer concerning
hazard insurance and taxes. Credit unions may provide notice to the
servicer electronically or it may take the form of a copy of the notice to
the borrower.
Record The credit union must retain a record of the receipt of the notices by
Retention the borrower and the servicer for the period of time the credit union
owns the loan.
Forced If a credit union, or a servicer acting on its behalf determines at any

Placement time during the term of the loan that the building or mobile home, and
Provisions any personal property securing the loan, is not covered by flood
insurance or is covered in an amount less than the amount required,
then the credit union or its servicer must provide notice and an
opportunity for the borrower to obtain the necessary amount of flood
insurance, at the borrower’s expense. If the borrower fails to obtain
flood insurance within 45 days after notification, then the credit union
or its servicer must purchase or “force place” flood insurance in the
appropriate amount on the borrower’s behalf. The credit union or its
servicer may charge the borrower for the cost of the premiums and fees
incurred in purchasing the insurance.
Escrow If a credit union requires the escrow of taxes, insurance premiums,

Accounts fees, or any other charges for a loan secured by residential improved
real estate or a mobile home that is made, increased, extended or
renewed on or after November 1, 1996, it must also require the escrow
of all premiums and fees for flood insurance.
Penalties for Penalties exist for violations of:

Non-
cornpliance 0 Escrow requirements;
0 Notice requirements; and
0 Forced placement requirements.
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EXAMINER’S GUIDE
If a credit union is found to have a pattern or practice of committing

violations, NCUA shall assess civil penalties in an amount not to
exceed $350 per violation with a total amount against any one credit
union not to exceed $100,000 in any calendar year. Any penalty
assessed will be paid into the National Flood Mitigation Fund.
Liability for violations cannot be transferred to a subsequent purchaser
of a loan. Liability for penalties expires four years from the time of the
occurrence of the violation.
Notice to When a credit union makes, increases, extends, renews, sells, or

FEMA transfers a loan secured by a building or mobile home located or to be
located in a SFHA, the credit union must notify the Director of FEMA,
or the Director’s designee (the insurance carrier), in writing of the
identity of the servicer of the loan.
The credit union must notify the Director of FEMA, or the Director’s
designee, of any change in the servicer of the loan within 60 days after
the effective date of the change. Credit unions may provide this notice
electronically, if electronic submission is satisfactory to the Director of
FEMA, or the Directors’ designee.

Coverage and Internal Control:

- Review the methods used by the credit union to ascertain
whether improved real estate or mobile homes are or will be
located in a SFHA;
- Verify that the process used accurately identifies SFHAs; and
- Determine if the communities in which identified SFHAs are
located participate in the NFIP.
0 Property Determination Requirements:

- Verify that the credit union accurately prepares flood zone
determinations on the standard flood hazard determination
form;
- Verify that the credit union only relies on a previous
determination if it is not more than seven years old, is recorded
Page 19K-8
on the standard flood hazard determination form, and is not in a

community that has been remapped;
- Review the contractual obligations to ascertain that flood
insurance requirements are identified and compliance
responsibilities are adequately addressed if the credit union
uses a third party to prepare flood zone determinations; and
- Verify that the credit union’s escrow procedures comply with
Section 760.5 of the NCUA Rules and Regulations.
Forced Placement Requirements:

- Ascertain that the credit union has appropriate policies and
procedures in place to exercise its forced placement authority if
the credit union determines that flood insurance coverage is
less than the amount required by the FDPA;
- Verify the following if the credit union is required to force
place insurance:
i. That it provides written notice to the borrower that flood

insurance is required; and
ii. That if the required insurance is not purchased by the
borrower within 45 days from the date of notification, the
credit union purchases the required insurance on the
borrower’s behalf.
Checklists
- Complete the FDPA checklist in AIRES, which provides
informative guidance on the requirements of the regulation for
each question.
- Report a violation on the Violations form in AIRES.
Add itionaI Additional information is available on the Federal Reserve Board’s

Information web site at http://www.federalreserve.gov.The Publications Services
Unit at (202) 452-3245 furnishes copies of the regulation and staff
commentaries issued by the Federal Reserve System.
Page 19K-9
HOMEOWNERS PROTECTION ACT - APPENDIX 19L
Examination Determine whether the credit union has implemented procedures
0bjective for complying with the requirements of the Homeowners
Protection Act (HOPA)
Associated Compliance risk can occur when the credit union fails to
Risks implement the necessary controls to comply with HOPA
Reputation risk can occur when the credit union incurs fines and
penalties as a result of failure to comply with HOPA
Strategic risk can occur when the board of directors fails to
perform necessary due diligence in reviewing existing and
prospective products and services for compliance with HOPA
Overview HOPA applies to residential mortgage transactions consummated on or

after July 29, 1999, with the purpose of financing the acquisition,
initial construction, or refinancing a single family dwelling that serves
as a principal residence.
HOPA addresses the difficulties homeowners have experienced in

canceling private mortgage insurance (PMI). The Act establishes
provisions for the cancellation and termination of PMI, establishes
disclosure and notification requirements, and requires the return of
unearned premiums. HOPA protects homeowners by prohibiting life of
loan PMI for borrower-paid products, and it establishes uniform
procedures for cancellation of PMI policies.
Termination HOPA provides three methods to terminate PMI. The credit union
of PMI should monitor PMI to ensure cancellation occurs in one of the
following three ways:
Borrower cancellation. The borrower must:
- Submit a written request for cancellation;

- Maintain a good payment history with respect to the loan;
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EXAMINER'S GUIDE
- Maintain a current balance as required by terms of loan (at time

of request); and
- Satisfy any requirement of the credit union (as of the date of the
written request for cancellation) such as evidence (1) of the
residence's value, or (2) that the mortgage is unencumbered by
other liens.
0 Automatic termination. The credit union automatically terminates

PMI based on the date the principal balance of the mortgage
reaches 78 percent of the original value of the property securing the
loan according to the initial amortization schedule (or amortization
schedule in effect for adjustable rate mortgages);
0 Final termination. If the borrower has not cancelled PMI or the

credit union has not automatically terminated PMI, the credit union
must cancel or terminate it by the first day of the month
immediately following the midpoint of the amortization period of
the loan if the member is current on payments. The midpoint of the
amortization period is defined as the point in time halfway between
the consummation of the loan and the end of the amortization
schedule.
If the borrower or credit union alters the terms of the loan before a
residential mortgage transaction, the credit union must recalculate the
cancellation date, termination date, or final termination to reflect the
modified terms and conditions of the loan.
The credit union may not require any further PMI payments from the
member after 30 days of termination or cancellation. Generally within
45 days of termination or cancellation of PMI, the servicer must return
all unearned premiums to the member.
HOPA provides exceptions for high risk loans. Borrower cancellation

and automatic termination do not apply to loans designated as high risk
at the time of consummation.
High risk mortgages include:
Page 19L-2
HOMEOWNERS PROTECTION ACT -APPENDIX 19L
Conforming loans defined as high risk by the Federal National

Mortgage Association (FNMA) and/or the Federal Home Loan
Mortgage Corporation (Freddie Mac); and
Non-conforming loans defined as high risk by the lender.
The final termination provisions do apply to high risk mortgage loans.
Disclosure In the case of mortgages requiring PMI, the credit union must disclose
Requirements the following in writing:
Initial amortization schedule (fixed rate only);

0 Notice of the ways to cancel or terminate PMI; and
0 Notice of the exemptions to the right to cancel and automatic
termination.
When the credit union uses a third-party to service its loans, the
servicer must provide annual written statements stating:
The right to cancel or terminate PMI; and

0 The address and telephone number the member may use to contact
the servicer.
Notification Generally within 30 days after the cancellation or termination of the

of PMI, the servicer shall notify the member in writing of the following:
Cancellation
or 0 PMI has terminated and member no longer has PMI; and
Term ination 0 The member owes no further premiums, payments, or fees in
connection with PMI.
Disclosure In the case of lender-paid PMI, the credit union must provide written
Requirements disclosure to the member not later than the date of the loan
for Lender commitment that lender-paid PMI:
Paid PMI
Differs from borrower-paid PMI (include differences);
Results in a higher interest rate (generally); and
Terminates only upon refinancing of the loan.
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EXAMINER’S GUIDE
Within 30 days after the termination date that would apply in the case
of borrower paid PMI, the servicer shall provide a written notice to the
member indicating they may wish to review financing options that
could eliminate the requirement for PMI.
Fees and The credit union may not impose any fee on the member with respect
Penalties to the provision of any notice or information required by HOPA.
Penalties for violating this Act include liability to the member to

whom the violation relates. Liability may include actual damages,
statutory damages, costs of actions, and reasonable attorney fees.
Statutory damages are limited to $2,000 in individual cases and the
lesser of $500,000 or 1 percent of net worth in class action cases.
Examination In reviewing HOPA, examiners should:

Procedures
Review the credit union’s HOPA policies and procedures;
Determine the credit union provides the required written
disclosures in residential mortgage transactions;
Review recent annual disclosure provided to member;
Review the credit union’s process for canceling PMI upon
borrower’s request;
Determine the credit union has controls in place to ensure proper
processing of the automatic and final termination provisions of
HOPA;
0 Determine the credit union complies with the notification
requirements upon termination or cancellation of PMI;
Determine the credit union provides appropriate disclosures in the
cases of lender paid mortgage insurance.
Examiners should cite material emerging or unresolved deficiencies in

the examination report. The examiner should discuss immaterial
exceptions with management.
Page 19L-4
CONSUMER LEASING ACT -APPENDIX 19M
Examination 0 Determine whether the credit union provides meaningfbl and
Objectives required disclosures to lessees
Determine if the credit union limits the amount of balloon
payments in lease transactions
0 Determine if the credit union accurately discloses lease terms in
advertising
Category implement the necessary controls to comply with the Consumer
Leasing Act.
Overview The Federal Reserve Board issued Regulation M, the Consumer

Leasing Act, to implement the consumer leasing portions of the Truth
in Lending Act. The regulation requires meaningful disclosures to
lessees for comparing consumer lease terms with other leases and
credit transactions. It also limits balloon payments in consumer lease
transactions and provides for the accurate disclosures of lease terms in
advertisements.
Regulation M applies to lessors of personal property under consumer

leases, as these terms are defined below.
Definitions For purposes of the Consumer Leasing Act, the following definitions
apply:
Consumer lease: a lease that contains the following characteristics:

Entered into by a natural person;
For the use of personal property primarily for personal, family, or household
purposes;
For a period of time exceeding four months; and
For a total contractual obligation not exceeding $25,000.
The following are not consumer leases:

A lease that meet the definition of a credit sale in §226.2(a) of Regulation Z;
A lease for agricultural, business, or commercial purposes;
0 A lease made to an organization; and
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EXAMINER'S GUIDE
A lease transaction that is incidental to the lease of real property where the
lessee has no liability for the personal property at the end of the lease term,
except for abnormal wear and tear, and the lessee has no option to purchase
the leased property.
Lessee: a natural person who enters into or is offered a consumer lease.
Lessor: a person who regularly leases, offers to lease, or arranges for the leasing
of personal property under a consumer lease. A person who has leased, offered,
or arranged to lease personal property more than five times in the current or
preceding calendar year is subject to Regulation M.
Open-end lease: a consumer lease in which the lessee's responsibility at the end
of the lease term is based on the difference between the residual value of the
leased property and its realized value.
Person: a natural person or organization.
Personal property: any property that is not real property under the law of the
state where the property is located at the time it is offered or made available for
lease.
Realized Value: 1) the price received by the lessor for the leased property at
disposition, 2) the highest offer for disposition of the leased property or 3) the
fair market value at the end of the lease term.
Residual Value: the value of the leased property at the end of the lease term, as
estimated or assigned at consummation by the lessor, used in calculating the base
periodic payment.
Disclosures Credit unions must make all disclosures required under Regulation M
clearly and conspicuously in writing and in a form the consumer can
keep. Electronic disclosures are permissible.
Generally, credit unions must make subsequent disclosures for a lease

renegotiation (a consumer lease is satisfied and replaced by another
lease undertaken by the same consumer) or lease extension
(continuation of an existing lease beyond six months from the original
lease term.) Subsequent disclosures are not required when another
person assumes a consumer lease.
Advertising An advertisement must include specific terms of the lease. In general,

an advertisement for a consumer lease may state that a specific lease of
property at specific amounts or terms is available only if the lessor
usually and customarily leases or will lease the property at those
amounts or terms.
Page 19M-2
CONSUMER LEASING ACT - APPENDIX 19M
Lessors may not use the terms "annual percentage rate" or "annual
lease rate" or any equivalent term in its advertisements. If the lessor
provides a percentage rate in advertisements or other documents, a
notice stating "this percentage may not measure the overall cost of
financing this lease" must be included.
Triggering An advertisement that includes any of the following Trigger Terms

Terms shall contain additional disclosures:
The amount of any payment;

Number of required payments; or
"Down payment" (even if it is zero), capitalized cost reduction, or
other payment required at or prior to consummation.
Penalties and Failure to comply with the Consumer Leasing Act may result in
Record criminal and civil penalties. Lessors must retain evidence documenting
Retention their compliance with the Consumer Leasing Act for at least two years
after the date the disclosures were required.
State Law Regulation M preempts state law, except where state law provides
greater protection and benefit to the consumer.

Determine if the credit union has made or arranged consumer

leases since the last examination;
Review the forms used in granting consumer leases;
Determine that disclosures were finished to members before
consummation of the lease;
Determine that lease disclosures are conspicuous, written in a form
the consumer may keep, and consistent with the model disclosure
forms;
Determine that the credit union includes the following in its
consumer leasing disclosures:
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EXAMINER'S GUIDE
- Description of the leased property;

- Amount due at lease signing;
- Payment schedule and total amount of periodic payments;
- Other charges (i.e., the amount of any liability the lease
imposes upon the lessee at the end of the lease term);
- Total of payments;
- Payment calculation:
1. Gross capitalized cost;
..
11. Capitalized cost reduction;
...
111. Adjusted capitalized cost;
iv. Residual value;

V. Depreciation and any amortized amounts;
vi . Rent charges;
..
vii. Total of base periodic payments;
viii. Lease term;
ix. Base periodic payment;
x. Itemization of other charges; and
xi. Total periodic payment;
Early termination:
i. Conditions and disclosure of charges; and
ii. Early-termination notice;
Maintenance responsibilities:
i. Statement of responsibilities;
ii. Wear and use standard; and
iii. Notice of wear and use standard;
Purchase option:
i. End of lease term; and
ii. During lease term;
Statement referencing non-segregated disclosures;
Liability between residual and realized values;
Right of appraisal;
Liability at end of lease term:
i. Rent and other charges;
ii. Excess liability; and
iii. Mutually agreeable final adjustment;
Fees and taxes;
Insurance:
i. Through the lessor; or
ii. Through a third party;
Warranties or guarantees;
Page 19M-4
CONSUMER LEASING ACT - APPENDIX 19M
- Penalties and other charges for delinquency;

- Security interest; and
- Limitations on rate information.
0 Determine that the credit union discloses the following when
advertising a triggering term:
- That the transaction is a lease;
- The total amount due at lease signing, or that no payment is
required;
- The number, amounts, due dates or periods of scheduled
payments, and the total of such payments under the lease;
- A statement of whether or not the lessee has the option to
purchase the leased property and, if so, when and at what price;
and
- A statement of the lessee’s liability, if any, for the difference
between the residual value of the leased property and its
realized value at the end of the lease term.
0 Complete the Regulation M Checklist in AIRES. The checklist
regulation for each question.
0 Report a violation of Regulation M on the Violations form in
AIRES.
Add itional Additional information is available on the Federal Reserve Board’s

Information web site at http://www.federalreserve.gov. The Publications Services
Unit at (202) 452-3245 can also furnish copies of the regulation and
staff commentaries issued by the Federal Reserve System.
Page 19M-5
I4
PRIVACY OF CONSUMER FINANCIAL
INFORMATION -APPENDIX 19N
Examination Assess the quality of a credit union’s compliance management
Objectives policies and procedures for implementing the Privacy of Consumer
Financial Information (Privacy Regulation) to determine whether
the information about its policies and practices to members and
consumers in the credit union’s notices conforms to the credit
union’s actual procedures and practices
Determine the reliability of the credit union’s internal controls and
procedures for monitoring compliance with the Privacy Regulation
0 Determine the credit union’s compliance with the Privacy
Regulation
0 Initiate effective corrective actions for violations of law or
deficient policies or internal controls
Associated Compliance risk can occur when the credit union fails to
Risks implement the necessary controls to comply with the Privacy Act;
and
Reputation risk can occur when members of the credit union learn
of its failure to comply with the Privacy Act.
Overview Title V, Subtitle A of the Gramm-Leach-BlileyAct (the “Act”)

governs the treatment of nonpublic personal information about
consumers by financial institutions. Section 502 of Subtitle A, subject
to certain exceptions, prohibits a financial institution from disclosing
nonpublic personal information about a consumer to nonaffiliated third
parties, unless the institution satisfies various notice and opt-out
requirements, and provided that the consumer has not elected to opt
out of the disclosure. Section 503 requires the institution to provide
notice of its privacy policies and practices to its customers. Section
504 authorizes the issuance of regulations to implement these
provisions.
Part 71 6 of the NCUA Rules and Regulations implement provisions of

the Act governing the privacy of consumer financial information. The
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EXAMINER’S GUIDE
regulation establishes rules governing duties of a credit union to

provide particular notices and limitations on its disclosure of
nonpublic personal information, as summarized below:
A credit union must provide a notice of its privacy policies, and

allow the consumer to opt out of the disclosure of the consumer’s
nonpublic personal information, to a nonaffiliated third party if the
disclosure is outside of the exceptions in NCUA Rules and
Regulations $716.13, $716.14 or $716.15;
Regardless of whether a credit union shares nonpublic personal
information, the credit union must provide notices of its privacy
policies to its members;
A credit union generally may not disclose member account
numbers to any nonaffiliated third party for marketing purposes;
and
A credit union must follow reuse and redisclosure limitations on
any nonpublic personal information it receives from a nonaffiliated
financial institution.
Definitions Discussion of the duties and limitations imposed by the Privacy

and Key Regulation involves using a number of key concepts. These concepts
Concepts include “financial institution,” “nonpublic personal information,”
“nonaffiliated third party,” the “opt out” right and the exceptions to
that right, and “consumer” and “member.” Each concept is briefly
discussed below. A more complete explanation of each appears in the
regulation.
Financial A financial institution is any institution the business of which engages

Institution in activities that are financial in nature or incidental to such financial
activities, as determined by section 4(k) of the Bank Holding Company
Act of 1956. Financial institutions can include banks, credit unions,
securities brokers and dealers, insurance underwriters and agents,
finance companies, mortgage bankers, and travel agents.
Nonpublic Nonpublic personal information generally is any information that is

Personal not publicly available and that:
Information
Page 19N-2
PRWACY OF CONSUMER FINANCIAL INFORMATION -APPENDIX 19N
A consumer provides to a credit union to obtain a financial product

or service from the credit union;
Results from a transaction between the consumer and the credit
union involving a financial product or service; or
A credit union otherwise obtains about a consumer in connection
with providing a financial product or service.
Information is publicly available if a credit union has a reasonable

basis to believe that the information is lawfully made available to the
general public from government records, widely distributed media, or
legally required disclosures to the general public. Examples include
information in a telephone book or a publicly recorded document, such
as a mortgage or securities filing.
Nonpublic personal information may include individual items of

information as well as lists of information. For example, nonpublic
personal information may include names, addresses, phone numbers,
social security numbers, income, credit score, and information
obtained through Internet collection devices (i.e., cookies.)
Special rules govern lists. Publicly available information would be

treated as nonpublic if it were included on a list of consumers derived
from nonpublic personal information. For example, a list of the names
and addresses of a credit union’s members would be nonpublic
personal information even though the names and addresses might be
published in local telephone directories because the list is derived from
the fact that a person is a member of the credit union, which is not
publicly available information.
However, if the credit union has a reasonable basis to believe that

certain member relationships are a matter of public record, then any
list of these relationships would be considered publicly available
information. For instance, a list of members with mortgages where the
mortgages are recorded in public records would be considered publicly
available information. The credit union could provide a list of such
members, and include on that list any other publicly available
information it has about the members without having to provide notice
or opt out.
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EXAMINER’S GUIDE
Nonaffiliated A nonaffiliated third party is any person except a credit union’s

Third Party affiliate or a person employed jointly by a credit union and a company
that is not the credit union’s affiliate. An “affiliate” of a credit union is
any company that controls, is controlled by, or is under common
control with the credit union. For federal credit unions, a credit union
service organization (CUSO) that is controlled by the credit union
would constitute the only affiliate. NCUA will presume a credit union
has a controlling influence if the CUSO is 67 percent owned by that
credit union or by that credit union and other credit unions.
Opt Out Right Consumers must be given the right to “opt out” of, or prevent, a credit
and Exceptions union from disclosing nonpublic personal information about them to a
nonaffiliated third party, unless an exception to that right applies. The
exceptions are detailed in 5716.13, 5716.14 or 5716.15.
As part of the opt out right, credit unions must give consumers a
reasonable opportunity and a reasonable means to opt out. What
constitutes a reasonable opportunity to opt out depends on the
circumstances surrounding the consumer’s transaction, but the credit
union must provide the consumer a reasonable amount of time to
exercise the opt out right. For example, it would be reasonable if the
credit union allows 30 days from the date of mailing a notice or 30
days after member acknowledgement of an electronic notice for the
consumer to return an opt out direction. What constitutes a reasonable
means to opt out may include check-off boxes, a reply form, or a toll-
free telephone number, again depending on the circumstances
surrounding the consumer’s transaction. It is not reasonable to require
a consumer to write his or her own letter as the only means to opt out.
NCUA Rules and Regulations 5716.13, $716.14 and 5716.15 detail

exceptions to the opt out right. Credit unions need not comply with
opt-out requirements if they limit disclosure of nonpublic personal
information:
0 To a nonaffiliated third party to perform services for the credit

union or to function on its behalf, including marketing the credit
union’s own products or services or those offered jointly by the
credit union and another financial institution. The exception is
permitted only if the credit union provides notice of these
Page 19N-4
PRIVACY OF CONSUMER FINANCIAL INFORMATION - APPENDIX 19N
arrangements and by contract prohibits the third party from

disclosing or using the information for other than the specified
purposes. The contract must provide that the parties to the
agreement jointly offer, sponsor, or endorse a financial product or
service. However, if the service or function is covered by the
exceptions in $716.14 or $716.15 (discussed below), the credit
union need not comply with the additional disclosure and
confidentiality requirements of $716.13. Disclosure under this
exception could include the outsourcing of marketing to an
advertising company ($716.14):
- As necessary to effect, administer, or enforce a transaction that

a consumer requests or authorizes, or under certain other
circumstances that relate to existing relationships with
members. Disclosures under this exception could be in
connection with the audit of credit information, administration
of a rewards program, or to provide an account statement
($716.14); or
- For specified other disclosures that a credit union normally
makes, such as to protect against or prevent actual or potential
fraud; to the credit union’s attorneys, accountants, and auditors;
or to comply with applicable legal requirements, such as the
disclosure of information to regulators ($716.15.)
Consumer and The distinction between consumers and members is significant

Member because credit unions have additional disclosure duties with respect to
members. All members covered under the regulation are consumers,
but not all consumers are members.
A “consumer” is an individual, or that individual’s legal

representative, who obtains or has obtained a financial product or
service from a credit union used primarily for personal, family, or
household purposes.
A “financial service” includes, among other things, a credit union’s

evaluation or brokerage of information that the credit union collects in
connection with a request or an application from a consumer for a
financial product or service. For example, a financial service includes
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EXAMINER’S GUIDE
an evaluation of an application for membership, even if the application

is ultimately rejected or withdrawn.
Consumers who are not members are entitled to an initial privacy and
opt out notice only if the credit union wants to share their nonpublic
personal information with nonaffiliated third parties outside of the
exceptions.
A “member” is a consumer who has a “member relationship” with a

credit union. A “member relationship” is a continuing relationship
between a consumer and a credit union under which the credit union
provides one or more financial products or services to the consumer
used primarily for personal, family, or household purposes.
For the purposes of the privacy regulation, the term member will
include certain nonmembers. For example, the following are
considered members:
0 An individual who meets the credit union’s bylaws definition of

member;
0 A nonmember who has a share, share draft, or credit card account
held jointly with a member;
0 A nonmember who has a loan that the credit union services;
0 A nonmember who has an account in a low-income credit union;
and
0 A nonmember who has an account in a federally insured state-
chartered credit union pursuant to state law.
Credit unions must provide members initial and annual privacy notices
regardless of the information disclosure practices of their credit union.
A special rule exists for loans. When a member obtains a loan from a
credit union, and that is the only basis for the member relationship, if
the credit union subsequently transfers the servicing rights to that loan
to another financial institution, the member relationship transfers with
the servicing rights. However, any information on the borrower
retained by the credit union selling the servicing rights must be
accorded the protections due any consumer.
Page 19N-6
Note that isolated transactions alone will not cause a consumer to be

treated as a member. For example, if an individual purchases a
traveler’s check from a credit union where the person has no account,
the credit union will treat the individual as a consumer but not a
member of that credit union because the individual has not established
a member relationship. Likewise, if an individual uses the ATM of a
credit union where the individual has no account, even repeatedly, the
credit union may regard the individual as a consumer, but not a
member of that credit union.
Credit Union The Privacy Regulation establishes specific duties and limitations for a
Duties credit union based on its activities. Credit unions that intend to
disclose nonpublic personal information outside the exceptions will
have to provide opt out rights to their members and to nonmember
consumers. All credit unions have an obligation to provide an initial
and annual notice of their privacy policies to their members. All credit
unions must abide by the regulatory limits on the disclosure of account
numbers to nonaffiliated third parties and on the re-disclosure and
reuse of nonpublic personal information received from nonaffiliated
financial institutions.
A brief summary of credit union duties and limitations appears below.

A more complete explanation of each appears in the regulations.
Notice and Opt If a credit union intends to disclose nonpublic personal information
Out Duties to about any of its consumers (whether or not they are members) to a
Consumers nonaffiliated third party, and an exception does not apply, then the
credit union must provide to the consumer:
An initial notice of its privacy policies;

An opt out notice (including, among other things, a reasonable
means to opt out); and
A reasonable opportunity, before the credit union discloses the
information to the nonaffiliated third party, to opt out.
The credit union may not disclose any nonpublic personal information
to nonaffiliated third parties except under the enumerated exceptions
unless these notices have been provided and the consumer has not
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EXAMINER'S GUIDE
opted out. Additionally, the credit union must provide a revised notice
before the credit union begins to share a new category of nonpublic
personal information or shares information with a new category of
nonaffiliated third party in a manner that was not described in the
previous notice.
Note that a credit union need not comply with the initial and opt-out
notice requirements for consumers who are not members if the credit
union limits disclosure of nonpublic personal information to the
exceptions.
Special Rule for Loans. A credit union must provide an initial notice
to a co-borrower or guarantor on a loan, who has no other member
relationship with the credit union, if it shares the nonpublic personal
information with nonaffiliated third parties other than as allowed under
the exceptions. Credit unions may provide annual notices to the co-
borrowers and guarantors jointly.
Notice Duties to In addition to the duties described above, there are several duties
Members unique to members. In particular, regardless of whether the credit
union discloses or intends to disclose nonpublic personal information,
a credit union must provide notice to its members of its privacy
policies and practices at various times.
A credit union must provide an initial notice of its privacy policies

and practices to each member, not later than the time a member
relationship is established. $716.4(e) of the regulation describes the
exceptional cases in which delivery of the notice is allowed
subsequent to the establishment of the member relationship;
0 A credit union must provide an annual notice at least once in any
period of 12 consecutive months during the continuation of the
member relationship;
Generally, new privacy notices are not required for each new
product or service. However, a credit union must provide a new
notice to an existing member when the member obtains a new
financial product or service from the credit union, if the initial or
annual notice most recently provided to the member was not
accurate with respect to the new financial product or service; and
Page 19N-8
When a credit union does not disclose nonpublic personal

information (other than as permitted under $716.14 or $716.15)
and does not reserve the right to do so, the credit union has the
option of providing a simplified notice.
Requirements for The following requirements apply to privacy notices:

Notices
Clear and Conspicuous. Privacy notices must be clear and
conspicuous, meaning they must be reasonably understandable and
designed to call attention to the nature and significance of the
information contained in the notice. The regulations do not
prescribe specific methods for making a notice clear and
conspicuous, but do provide examples of ways in which to achieve
the standard, such as the use of short explanatory sentences or
bullet lists, and the use of plain-language headings and easily
readable typeface and type size. Privacy notices also must
accurately reflect the credit union’s privacy practices.
Delivery Rules. Credit unions must provide privacy notices so that

each recipient can reasonably be expected to receive actual notice
in writing, or if the consumer agrees, electronically. To meet this
standard, a credit union could, for example, (1) hand-deliver a
printed copy of the notice to its consumers, (2) mail a printed copy
of the notice to a consumer’s last known address, or (3) for the
consumer who conducts transactions electronically, post the notice
on the credit union’s web site and require the consumer to
acknowledge receipt of the notice as a necessary step to completing
the transaction.
For members only, a credit union must provide the initial notice (as
well as the annual notice and any revised notice) so that a member
can retain or subsequently access the notice. A written notice
satisfies this requirement. For members who obtain financial
products or services electronically, and agree to receive their
notices on the credit union’s web site, the credit union may provide
the current version of its privacy notice on its web site.
Notice Content. A privacy notice must contain specific disclosures.

However, a credit union may provide to consumers who are not
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EXAMINER’S GUIDE
members a “short form” initial notice together with an opt out

notice stating that the credit union’s privacy notice is available
upon request and explaining a reasonable means for the consumer
to obtain it. The following is a list of disclosures regarding
nonpublic personal information that credit unions must provide in
their privacy notices, as applicable:
Categories of information collected;

Categories of information disclosed;
Categories of affiliates and nonaffiliated third parties to whom
the credit union may disclose information;
Policies with respect to the treatment of former members’
information;
Information disclosed to service providers and joint marketers
($716. 13);
An explanation of the opt out right and methods for opting out;
Any opt out notices the credit union must provide under the
Fair Credit Reporting Act with respect to affiliate information
sharing;
Policies for protecting the security and confidentiality of
information; and
A statement that the credit union makes disclosures to other
nonaffiliated third parties as permitted by law under $716.14
and $716.15.
Limitations on A credit union must not disclose an account number or similar form of
Disclosure of access number or access code for a credit card, share, or transaction
Account account to any nonaffiliated third party (other than a consumer
Numbers
reporting agency) for use in telemarketing, direct mail marketing, or
other marketing through electronic mail to the consumer.
The disclosure of encrypted account numbers without an

accompanying means of decryption, however, is not subject to this
prohibition. The regulation also expressly allows disclosures by a
credit union to its agent to market the credit union’s own products or
services (although the credit union must not authorize the agent to
directly initiate charges to the member’s account.) Also not barred are
disclosures to participants in private-label or affinity card programs,
Page 19N-10
where the participants are identified to the member when the member
enters the program.
Re-disclosure If a credit union receives nonpublic personal information from a

and Reuse nonaffiliated financial institution, the credit union's disclosure and use
Limitations On of the information is limited.
Nonpublic
Personal
Information For nonpublic personal information received under a $716.14 or
Received $716.15 exception, the credit union is limited to:
- Disclosing the information to the affiliates of the financial

institution from which it received the information;
- Disclosing the information to its own affiliates, who may, in
turn, disclose and use the information only to the extent that the
credit union can do so; and
- Disclosing and using the information pursuant to a $716.14 or
$7 16.15 exception (for example, a credit union receiving
information for account processing could disclose the
information to its auditors).
0 For nonpublic personal information received other than under a

$716. 14 or $716.15 exception, the credit union's use of the
information is unlimited, but its disclosure of the information is
limited to:
- Disclosing the information to the affiliates of the financial

institution from which it received the information;
- Disclosing the information to its own affiliates, who may, in
turn disclose the information only to the extent that the credit
union can do so; and
- Disclosing the information to any other person, if the disclosure
would be lawful if made directly to that person by the financial
institution from which it received the information. For
example, a credit union that received a member list from
another credit union could disclose the list (1) in accordance
with the privacy policy of the credit union that provided the
list, (2) subject to any opt out election or revocation by the
members on the list, and (3) in accordance with appropriate
exceptions under $716.14 and $716.15.
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EXAMINER’S GUIDE
Other Examiners should keep in mind the following when reviewing a credit
Consider- union’s privacy policies and procedures:
ations
Fair Credit Reporting Act. The regulations do not modify, limit, or
supersede the operation of the Fair Credit Reporting Act.
State Law. The regulations do not supersede, alter, or affect any state
statute, regulation, order, or interpretation, except to the extent that it is
inconsistent with the regulations. A state statute, regulation, order, etc.
is consistent with the regulations if the protection it affords any
consumer is greater than the protection provided under the regulations,
as determined by the FTC.
Grandfathered Service Contracts. Contracts that a credit union has

entered into, on or before July 1,2000, with a nonaffiliated third party
to perform services for the credit union or functions on its behalf, as
described in $716.13, will satisfy the confidentiality requirements of
§716.13(a)(l)(ii) until July 1,2002, even if the contract does not
include a requirement that the third party maintain the confidentiality
of nonpublic personal information.
Guidelines for Protecting Member Information. The regulations

require a credit union to disclose its policies and practices for
protecting the confidentiality, security, and integrity of nonpublic
personal information about consumers (whether or not they are
members). The disclosure need not describe these policies and
practices in detail, but instead may describe in general terms who is
authorized to have access to the information and whether the credit
union has security practices and procedures in place to ensure the
confidentiality of the information in accordance with the credit union’s
policies.
NCUA has published guidelines (Appendix A to 12 C.F.R. Part 748 of

the Rules and Regulations), pursuant to section 50 1(b) of the Gramm
Leach Bliley Act, that address steps a credit union may take in order to
protect member information. The guidelines relate only to information
about members, rather than all consumers.
Page 19N-12
REAL ESTATE SETTLEMENT PROCEDURES ACT -
APPENDIX I 9 0
Examination Determine whether the credit union has implemented policies and
0bjective procedures complying with the requirements of the Real Estate
Settlement Procedures Act (RESPA)
Associated 0 Compliance risk can occur when the credit union fails to
Risks implement the necessary controls to comply with RESPA;
penalties as a result of failure to comply with RESPA; and
0 Strategic risk can occur when the board of directors fails to
perform necessary due diligence in reviewing existing and
prospective products and services for compliance with RESPA.
Overview RESPA provides borrowers with pertinent and timely disclosures

associated with the nature and costs of the real estate settlement
process. It addresses disclosure requirements for the transfer, sale, or
assignment of servicing a loan. Also, RESPA protects borrowers
against certain abusive practices, such as kickbacks, and places
limitations upon the use of escrow accounts. The Department of
Housing and Urban Development’s (HUD) Regulation X implements
RESPA.
Coverage RESPA applies to “federally related mortgage loans.’’ It defines these

loans as any loan secured by a first lien on residential real property
designed principally for the occupancy of one to four families and
made by a lender regulated by any federal government agency, or
whose deposits any federal government agency insures.
Exempt transactions include (24 C.F.R. §3500.5(b)):
0 Loans on property of 25 acres or more;

0 Loans on vacant or unimproved property;
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EXAMINER'S GUIDE
Business purpose loans (except if an individual places a lien on a

1-4 family dwelling);
Temporary financing (i.e., construction or bridge loans);
Loan conversions not requiring a new note;
Assumptions that do not require lender approval; and
0 Secondary market transactions.
Special Credit unions will supply the special information booklet to each
Booklet purchase transaction applicant for a federally related mortgage loan by
Information delivering it or by placing it in the mail to the applicant no later than 3
business days after the credit union receives the application. When
there is more than one applicant for the loan, the credit union need
only provide a copy of the booklet to one of the applicants.
Part one of the booklet describes the settlement process, the nature of
charges, and suggests questions that the member may ask of lenders,
attorneys, and others to clarify what services these professionals will
provide for the charges quoted. It also contains information on the
rights and remedies available under RESPA and alerts the borrower to
unfair or illegal practices.
Part two of the booklet contains an itemized explanation of settlement

services and costs and sample forms and worksheets for cost
comparisons.
Good Faith The credit union must provide, no later than 3 business days after
Estimate receiving the written application, a clear and concise GFE of the
WE) amount or range for each settlement charge the borrower will likely
incur. The estimate of the amount or range for each charge must meet
the following requirements:
0 Present a reasonable relationship to the borrower's ultimate cost for

each settlement charge; and
0 Evidence experience in the locality or area of the property
involved.
GFEs need not exactly match the actual charges, but they should
approximate them. Credit unions may make the disclosures using
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REAL ESTATE SETTLEMENT PROCEDURES ACT-APPENDIX 19 0
commercial forms, or may develop a separate one. Credit unions must

use clear and concise forms that include the lender's name. The forms
must also contain in boldface type the following or a substantially
similar statement (the statement need not refer to real estate taxes if a
the credit union provides a GFE for them):
This form does not cover all items you will be required to pay
in cash at settlement, for example, deposit in escrow for real
estate taxes and insurance. You may wish to inquire as to the
amounts of such other items. You may be required to pay other
additional amounts at settlement.
HELOCs do not require GFEs, because Regulation Z requires fee

disclosures.
Uniform The person conducting the settlement must complete the appropriate
Settlement form and must conspicuously and clearly itemize all charges imposed
Statement on the borrower and the seller in connection with the settlement. It
(HUD-1 or must indicate whether any title insurance premium included in such
HUD-IA) charges covers or insures the lender's interest in the property, the
borrower's interest, or both. (HELOCs do not require the statement.
Regulation Z requires the disclosures for HELOCs.)
The credit union must retain the Uniform Settlement Statements for
five years or until it disposes of its interest in the property.
Prohibitions RESPA provides fines up to $10,000 and imprisonment up to one year

for anyone who violates the section concerning kickbacks and
unearned fees.
Title RESPA states a seller cannot require property purchased with a

Companies federally related mortgage loan to buy title insurance from any
particular title company. Any seller who violates this is liable to the
buyer for three times all charges made for the title insurance.
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EXAMINER'S GUIDE
Escrow RESPA limits the amount that the credit union can require a borrower
Accounts to place in an escrow account. RESPA limits escrow funds at
settlement to the amount that would bring the accrual of taxes,
insurance premiums, and other charges current to the date of the first
full payment, plus one-sixth of the amount of such charges the member
will pay during the following 12 months. The Act further limits any
monthly escrow payment to no more than one-twelfth of the
anticipated amount due for such charges during the following 12
months plus the amount necessary to maintain a balance not to exceed
one-sixth of the amount of charges due during that period. RESPA
provides guidance on how to handle escrow shortages and surpluses.
Within 45 days after establishing an escrow account in connection with

a federally related mortgage loan, the servicer must send an itemized
list to the borrower of expected payments from the account and the
expected dates of the payments. The credit union may give the list to
the borrower at closing. HUD regulations incorporate the escrow
requirements into the uniform settlement statement. The servicer must
also give annual notice to the borrower of any shortage in an escrow
account.
The servicer must send an annual statement by January 30 of the next

year to the borrower itemizing payments made into and from the
account. The servicer may not charge a fee for the annual statement.
RESPA provides penalties for violating this requirement.
Servicing of The credit union shall disclose to each applicant at the time of
Mortgage application or within 3 days of the application a Servicing Disclosure
Loans Statement. The statement shall include:
0 Whether the credit union may transfer to another person the

servicing of the loan;
0 The percentage of loans, within the nearest 25%, made by the
credit union during the past 3 calendar years for which the credit
union transferred servicing (credit unions need not disclose
information before 1989);
0 The best estimate of the percentage of all loans made during a 12
month period beginning on the date of origination for which the
credit union may assign, sell, or transfer servicing; and
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REAL ESTATE SETTLEMENT PROCEDURES ACT-APPENDIX 19 0
A written and signed acknowledgement that the applicant and any

co-applicant hashave read and understood the disclosure.
When a servicer transfers a loan, both the transferor and the transferee
servicers must make the following disclosures to the borrower:
The effective date of the first payment to the transferee;

The name, address, and toll-free or collect call telephone number
of the transferee;
The transferor’s and transferee’s toll-free or collect call telephone
numbers, which the borrower may use to make inquiries relating to
the transfer;
The date on which the transferor will cease to accept payments,
and the date when the transferee will begin to accept payments;
Any information concerning the effect of the transfer on the
availability or terms of any optional insurance, and any action that
the borrower must take to maintain coverage;
A statement that the transfer does not affect any term of the
mortgage, other than the terms directly related to servicing the
mortgage; and
A statement of the borrower’s rights in connection with complaint
resolution.
The transferor must make the disclosures at least 15 days before the
transfer; the transferee must make the disclosures within 15 days after
the transfer. Both the transferor and transferee may make the
disclosures within 30 days after the transfer, if one of the following
specifies the reason for the transfer:
Termination of the servicing contract for cause;

The servicer enters bankruptcy proceedings; or
Proceedings for conservatorship or receivership of the servicer, or
an entity that owns or controls the servicer.
These time limits do not apply if the credit union provided written
notice to the borrower at settlement.
During the 60-day period after the borrower’s first payment due date,
the transferee may not consider a payment late if the transferor receives
the payment in a timely manner.
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EXAMINER'S GUIDE
RESPA provides specific guidelines on how a servicer must respond to

borrower inquiries. Whoever fails to comply with any provision
concerning the servicing is liable to the borrower for damages and
costs.

Procedures
0 Review the credit union's RESPA policies and procedures;
0 Determine the credit union provides the required written
disclosures (Special Information Booklet, GFE, HUD 1 or HUD 1-
A, transfer of servicing, and escrow disclosures) in residential
mortgage transactions; and
0 Determine the credit union only receives reasonable and
appropriate fees for services provided (no kickbacks or unearned
fees.)

management and, if material, cite them in the examination report.
Page 19 0 - 6
RIGHT TO FINANCIAL PRIVACY - APPENDIX 19P
Examination 0 Determine whether the credit union has implemented policies and
0bjective procedures for complying with the requirements of the Right to
Financial Privacy Act (RFPA)
Risks implement the necessary controls to comply with RFPA; and
0 Reputation risk can occur when members of the credit union learn
of its failure to comply with RFPA.
Overview RFPA protects the personal financial privacy of federal credit union
members by restricting access to the member's financial records.
RFPA sets forth the conditions required before a credit union may
grant access to or provide copies of financial records of a member to a
government authority. In most cases, the credit union must obtain
authorization from the member or secure from the government
authority a subpoena or summons, a search warrant, a judicial
subpoena, or a formal written request. Some exceptions to this rule
include, but are not limited to:
0 Credit union employee has information on a possible violation of a

statute or regulation. RFPA provides that the credit union or any
official, employee, or agent is not liable to the member for making
such disclosure;
0 Records needed to perfect a security interest, prove a claim in
bankruptcy, collect a debt, or process an application with regard to
a government loan; and
0 Records needed by supervisory agency (NCUA) to perform
examination.
Examination Examiners should determine the credit union understands RFP, and.
Procedures has procedures in place to comply with RFPA.
Page 19P-1
/9 F a &d
SOLDIERS’ AND SAILORS’ CIVIL RELIEF ACT -
APPENDIX 19Q
Objective procedures for complying with the requirements of the Soldiers’
and Sailors’ Civil Relief Act (SSCRA)
Risks implement the necessary controls to comply with SSCRA; and
0 Reputation risk can occur when members of the credit union learn
of its failure to comply with SSCRA.
Overview SSCRA provides financial relief and legal protections for persons on
active duty. Some of the key provisions include:
0 Credit unions may generally not charge over a 6 percent interest

rate on debt obligations if the borrower incurred the obligation
before entering active duty;
0 Credit unions generally may not foreclose on property securing a
mortgage during the period of active duty or for 3 months
thereafter, if the mortgage predated the borrower’s active duty; and
Credit unions must abide by special procedures in obtaining default
judgments or proceeding with other court actions.

Procedures
0 Review the credit union’s SSCRA policies and procedures; and
0 Determine the credit union has implemented policies and
procedures to comply with SSCRA requirements.
Add itionaI Examiners may obtain additional information at the following website:
Information http://www.jagcnet.army.mil/legal.
Page 194-1
14 l2-d
HOME OWNERSHIP AND EQUITY PROTECTION
ACT -APPENDIX 19R
Examination Determine whether the credit union has procedures in place to
0bjectives recognize mortgages meeting the requirements of the Home
Ownership and Equity Protection Act (HOEPA)
0 Determine whether the credit union has policies and procedures in
place for complying with the requirements of HOEPA
Risks implement the necessary controls to comply with HOEPA
penalties as a result of failure to comply with HOEPA
0 Strategic risk occurs when the board of directors fails to perform
necessary due diligence in reviewing existing and prospective
products and services for compliance with HOEPA
Overview HOEPA regulates high cost loans and applies to home equity loans,
second mortgages, or refinances secured by primary residences with
high costs. HOEPA defines high costs as those that contain the
following:
0 APR exceeds by more than 10% the rate on a Treasury note of

comparable maturity, or
0 Fees and points at or before closing exceed the larger of $480 (as
of 2001, adjusted annually) or 8% of the total loan amount.
HOEPA does not limit the interest rate or the finance charge a credit
union can charge a member (although 9 107(5)(vi) of the Federal
Credit Union Act provides such a limitation.)
Requirements HOEPA requires specific disclosures for mortgages that fall within the
for Certain regulation. The regulation provides necessary language to include in
Mortgages the disclosures. In general, the credit union must give the member the
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EXAMINER'S GUIDE
required disclosures not less than 3 business days before

consummation of the transaction.
A mortgage falling under the requirements of HOEPA may not provide

for an interest rate applicable after default that is higher than the
interest rate that applies before default. HOEPA also has the following
provisions:
0 No balloon payments (if term is less than 5 years);

No negative amortization;
0 No prepaid payments;
0 Prohibition on extending credit without regard to payment ability
of member; and
0 Requirements for payments under home improvement contracts
(directly to contractor).
Reverse HOEPA includes additional disclosures for reverse mortgages that fall
Mortgage within its requirements.
Disclosure
PenaIt ies The credit union is open to civil liability for failing to comply with any
portion of HOEPA.
Examination If examiners review for HOEPA, their review should include the
Procedures following:
0 Reviewing the credit union's HOEPA policies and procedures;

0 Determining whether the credit union has any loans meeting the
criteria of HOEPA; and
0 Reviewing a sample of loans meeting the HOEPA criteria for
compliance and required disclosures.
Additional The Federal Reserve Board added HOEPA as a subsection of the Truth
Information in Lending Act (Reg Z). HOEPA is located in $226.32 of the Truth in
Lending Act.
Page 19R-2
TRUTH IN LENDING ACT -APPENDIX 19s
0bjective procedures for complying with the requirements of the Truth in
Lending Act (TILA)
Risks implement the necessary controls to comply with TILA;
penalties as a result of failure to comply with TILA; and
Strategic risk occurs when the board of directors fails to perform
necessary due diligence in reviewing existing and prospective
products and services for compliance with TILA.
Overview TILA (Regulation Z) is a disclosure regulation developed to promote

the informed use of consumer credit by consumers. The required
disclosures assist consumers in shopping for credit based on terms and
cost. The regulation also gives consumers the right to cancel certain
transactions involving a lien on their primary residence, and it
regulates credit card practices and billing disputes. TILA imposes
some limitations on home equity and mortgage loans, and requires that
lenders state maximum interest rates on variable-rate mortgage plans.
TILA primarily applies to loans for personal, family, or household

purposes. Exempt transactions include credit in excess of $25,000
unless secured by real property or a dwelling, or student loans insured
or guaranteed by the US. government.
General A creditor that offers or extends consumer credit to any consumer must
Disclosures furnish disclosures. Every person (whether a creditor or not), who
advertises consumer credit, must comply with the advertising
provisions of the regulation.
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EXAMINER'S GUIDE
The creditor is a person who regularly extends consumer credit, and to

whom the borrower makes the initial payment of consumer credit. The
creditor must furnish the disclosures to the consumer.
In addition to disclosure requirements, Regulation Z imposes certain

restrictions on credit unions by regulating the:
Form and content of advertisements for consumer credit;

Issuance of credit cards; and
Consumer's liability for the unauthorized use of credit cards.
The regulation also provides certain rights to consumers by permitting

the consumer to:
Revoke a credit transaction, with some exceptions, if the credit

involves a security interest in the consumer's principal dwelling;
and
Assert against a credit card issuer claims and defenses arising out
of a credit card purchase if the consumer fails to resolve a dispute
satisfactorily with the person who honored the credit card.
Summary of Lenders must consider several factors when deciding whether a loan
Transactions requires Truth in Lending disclosures or must meet other Regulation Z
Covered requirements.
Generally, Regulation Z does not apply to a credit transaction unless:
The transaction applies to consumer credit (i.e., for personal,

family, or household use);
The creditor extends credit to a consumer (i.e., a cardholder, a
natural person, or, in a rescindable transaction, any non borrower
whose primary residence secures the loan);
The creditor regularly extends consumer credit (i.e., the person to
whom the borrower initially pays the debt); and
A written agreement makes the obligation payable in more than
four installments or subject to a finance charge.
Even if those conditions exist, the regulation still exempts the

transaction if real property or the consumer's principal dwelling does
Page 19s-2
not secure the obligation and the amount financed exceeds $25,000.
$226.3 contains other exempt credit transactions.
Summary of $226.3 normally exempts from all requirements of the regulation

Exempt transactions that do not have a consumer purpose. For example, a loan
Transactions made for working capital secured by the company president's personal
residence need not comply with the regulation because it has a
business purpose and therefore is not a rescindable transaction.
Credit Regulation Z divides covered consumer credit transactions into two

Categories categories, "open-end" (which includes 'home equity lines of credit')
and "closed-end" credit. The regulation provides requirements for each
separately.
Open-End Credit $226.2(a)(20)defines open-end credit as consumer credit extended

under a plan in which the credit union:
Reasonably contemplates repeated transactions;

0 May impose a finance charge from time to time on the outstanding
unpaid balance; and
0 Generally makes credit extensions available to the consumer
during the term of the plan (up to any limit set by the credit union)
to the extent that the consumer repays any outstanding balance.
Under open-end credit plans, the creditor h i s h e s the consumer with

appropriate disclosures before the consumer actually uses the account.
Later, when the consumer uses the account, the creditor provides
certain disclosures on each billing statement sent to the consumer.
Within the open-end credit category, special rules apply to home equity
loans and credit card transactions only, such as certain prohibitions on
the issuance of credit cards and restrictions on the right to offset a
cardholder's indebtedness.
$226.13, Billing-Error Resolution, mandates specific time frames and

resolution requirements upon the credit union's receipt of a billing
error notice. It states the requirements for correcting and crediting
disputed amounts to a member's account. It also covers the credit
Page 19s-3
EXAMINER’S GUIDE
union’srights after the resolution of a billing error on a credit card or

open-end credit plan.
Closed-End Closed-end credit encompasses all consumer credit not extended

Credit under an open-end plan including residential mortgage transactions
and installment credit contracts (e.g., direct loans by credit unions and
purchased dealer paper.) Under the closed-end credit concept, the
consumer receives a complete disclosure of the costs associated with
the credit transaction at any time before actual consummation of the
transaction.
Regulation Z provides separate rules applicable to closed-end credit for

residential mortgage transactions and loans secured by real property.
Those rules relate mostly to when creditors must make disclosures,
consumer rescission rights, and what constitutes finance charges.
General A credit union must make required disclosures (1) clearly and
Disclosure conspicuously, (2) in writing, (3) in a form that the consumer may
Provisions keep, (4) not buried in fine print, ( 5 ) visible without undue searching,
( 6 ) phrased to communicate information effectively, (7) grouped
together and segregated from all other written material, and (8) not
containing any information unrelated to the required disclosures.
When creditors must disclose the terms “finance charge” and “annual
percentage rate,” with a corresponding amount or percentage rate, the
creditors must make these terms more conspicuous than any other
required disclosure. Although a few exceptions to this rule exist (e.g., a
credit union need not make these terms more conspicuous in
advertisements), the purpose of giving those terms prominence is to
highlight their importance above all other disclosures. Credit unions
may accomplish this by using larger or bolder type, underlining,
marking with an asterisk, or printing in colored ink. The disclosures
should attract the consumer’sattention more readily than other required
terminology.
Multiple If a transaction includes more than one consumer, the credit union
Consumers may make the disclosures to any consumer that assumes primary
Page 19s-4
TRUTH IN LENDING ACT - APPENDIX 19s
liability on the obligation. §226.5(d) and §226.17(d) address such

instances. A credit union must make the disclosure to an endorser,
guarantor, or similar party who assumes primary liability. If the
borrower may rescind the transaction, the credit union must give one
copy of material disclosures and two copies of the rescission notice to
each person who has the right to rescind the transaction, whether or not
such person has primary liability or has signed the evidence of debt.
Record Credit unions must maintain evidence of compliance with all

Retention requirements of Regulation Z for at least 2 years after the date
mandated for action or disclosures by $226.25. The 2-year requirement
applies even though an obligation may have a maturity of less than 2
years, or, be prepaid, refinanced, or sold within the first 2 years.
Credit unions may retain evidence of compliance on microfilm,

microfiche, or by any other method that reproduces records accurately
(including computer programs.) The credit union need retain only
enough information to reconstruct the required disclosures or other
records.
COnSeqUen- The TILA authorizes NCUA as the federal regulatory agency to require
ces of credit unions to make monetary and other adjustments to the accounts
Noncom- of consumers when the true finance charge or APR exceeded the
pliance disclosed finance charge or APR by more than a specified accuracy
tolerance as addressed by 0 108(e) of the TILA. That authorization
extends to unintentional errors, including isolated violations (for
example, errors which occurred, often without a common cause, only
once or infrequently on a random basis).
Under certain circumstances, the TILA requires NCUA to order credit

unions to reimburse consumers when understatement of the APR or
finance charge involves:
Patterns or practices of violations (e.g., errors which occurred,

often with a common cause, consistently or frequently, reflecting a
pattern with a specific type or types of consumer credit);
0 Gross negligence; and
Page 19s-5
EXAMINER'S GUIDE
0 Willful noncompliance intended to mislead the person to whom the

credit union extended credit.
Any proceeding that a regulatory agency can bring against a creditor, it

can also bring against any assignee of the creditor if the violation
appears on the face of the disclosure statement, except where the
assignment was involuntary, as described by § 13 1(a) of the TILA.
Examination As it applies to these procedures, the term ''consumer credit'' means

Procedures credit subject to the provisions of Regulation Z. Examination
procedures fall within the categories of General and Adjustable Rate
Mortgages.
GeneraI In reviewing the credit union's compliance with TILA, examiners

should:
0 Determine the types of consumer credit (open-end and closed-end,

direct and indirect) offered by the credit union and the terms
applicable to each;
0 Obtain and review blank copies of forms used by the credit union
in extending all types of consumer credit. Determine that the credit
union has on file a legal opinion for any nonstandard forms they
may use including:
- Note and credit contract forms (including those furnished to

dealers);
- Disclosure statement forms;
- Rescission notices;
- Initial disclosure statement forms for open-end credit plans;
- Periodic billing statement forms;
- Notices regarding billing error resolution procedures; and
- Merchant agreements;
0 Determine which individuals actually perform the various activities

necessary to comply with the different provisions of Regulation Z.
Then, review the adequacy of the training received by those
individuals to enable them to carry out their assigned
Page 19s-6
responsibilities in conformity with TILA. For example, this would

include personnel engaged in:
- Completing disclosure statements;

- Completing and furnishing rescission notices;
- Preparing advertising copy for consumer credit; and
- Responding to public inquiries (by telephone or otherwise)
about the cost and terms of consumer credit;
Obtain and review any written directives and training materials

pertaining to employee responsibilities for ensuring institutional
compliance with Regulation Z; and
Determine the extent to which (if any) the internal or external

auditors or other credit union staff monitors or periodically reviews
the credit union's policies, procedures, practices, and staff to assess
results and ensure continued compliance with Regulation Z.
Adjustable Rate Review the credit union's policies, procedures and practices when
Mortgages completing the following steps:
Determine if the credit union offers open-end or closed-end

variable rate credit;
Review the ability of the computer system or servicer to handle the

credit union's variable rate products. Determine if the credit union
has adequate operating procedures and internal controls;
Verify whether internal or external auditors or other staff

periodically test the accuracy of the credit union's variable interest
rate adjustment system;
Determine the extent and adequacy of the instruction and training

received by those individuals who implement rate changes;
Determine whether the credit union has retained records of index

values (e.g., copies of the Federal Reserve Statistical Release).
(226.25(a));
Page 19s-7
EXAMINER'S GUIDE
0 Verify that the credit union correctly recorded account and loan
data into the credit union's calculation systems (e.g., its computer).
Determine the input accuracy of the following:
- Index value (226.6(a)(2)) and (226.19(b)(2)(ii));

- Method for calculating rate changes (226.6(a)(2)) and
(226.19(b)(2)(iii));
- Rounding method (226.6(a)(2)) and (226.19(b)(2)(iii));
- Adjustment caps (periodic and lifetime) (226.6(a)(2)) and
(226.19(b)(2)(vii)); and
Sample periodic disclosures for open-end variable rate accounts

(e.g., home equity loans) and closed-end rate change notices for
adjustable rate mortgage loans (ARMS):
- Compare the rate change date on the credit obligation to the

actual rate change date and to any rate change notice (226.7(g))
and (226.20(~)(2));
- Determine that the credit union bases the index on the terms of
the contract (e.g., the weekly average of 1-year Treasury
constant maturities, taken 45 days prior to the change date.)
(226.7(g)) and (226.20(~)(2));
- Determine that the credit union correctly computes the new
interest rate by adding the correct index value with the margin
stated in the note, plus or minus any contractual fiactional
adjustment (226.7(g)) and (226.20(c)( 1)); and
- Determine that the credit union bases the new payment on an
interest rate and loan balance in effect at least 25 days before
the payment change date (consistent with the contract)
(226.20(~)(4)).

management and, if material in the examination report.
Add itionaI Refer to the appendix on the Home Ownership and Equity Protection
Information Act (HOEPA) for additional requirements on certain real estate
transactions.
Page 19s-8
TRUTH IN SAVINGS ACT - APPENDIX 19T
Examination Determine whether the credit union complies with all required provisions
Objectives of the Truth in Savings (TIS) regulation
Determine whether the credit union provides all required account
disclosures to members and potential members within the required time
frames and ensures that account disclosures reflect the terms of the legal
obligation between the parties
Determine whether the credit union accurately discloses all required
information on periodic statements for covered accounts
Determine whether the credit union uses a permissible method for paying
dividends, and accurately applies other calculations (e.g., daily balance,
average daily balance, minimum balance, etc.)
Determine whether advertisements include all required information and
are not misleading or inaccurate (credit unions should maintain an
advertising file containing copies of the credit union's advertisements)
Determine whether the credit union maintains evidence of compliance (for
a period of two years) with all provisions of TIS
Associated Compliance risk can occur when the credit union fails to implement the
Risks necessary controls to comply with TIS;
Reputation risk can occur when the credit union incurs fines and penalties
as a result of failure to comply with TIS; and
Strategic risk can occur when the board of directors fails to perform
necessary due diligence in reviewing existing and prospective products
and services for compliance with TIS.
Overview Part 707 of the NCUA Rules and Regulations, Truth-in-Savings (TIS),
implements the Truth in Savings Act (TISA) of the Federal Deposit Insurance
Corporation Improvement Act of 1991. TISA exempts credit unions with
assets of $2 million or less, after subtracting any nonmember deposits, that are
not sufficiently automated.
TIS covers member accounts at all credit unions insured by (or eligible to be
insured by) the National Credit Union Share Insurance Fund (NCUSIF)
including federal credit unions (FCUs), federally insured state-chartered credit
Page 19T-1
EXAMINER’S GUIDE
unions (FISCUs), and non-federally insured credit unions (NFICUs.) Accounts

include share and deposit accounts such as shares, share drafts, and term share
(certificate) accounts held by, or offered to, a natural person member or
potential member primarily for a personal, family or household purpose.
Disclosures TIS enables members to compare accounts using uniform disclosures about
terms, fees, and rates. Credit unions must provide members or potential
members with account disclosure information:
0 Before an account is opened or a service is provided, whichever is earlier;

0 Upon request;
0 When the terms change (with a few exceptions), if the change adversely
affects the member;
0 On most term share accounts that renew or mature (depending on maturity
date);
0 On periodic statements; and
0 On advertisements.
Payment of TIS applies equally to interest-bearing deposit accounts at state-chartered

Dividends credit unions and to dividend-bearing share accounts at federal and state-
chartered credit unions. Confusion between the terms “share” and “deposit”
accounts and between “dividends” and “interest” could result in a violation of
Part 707.
On dividend and interest-bearing accounts, TIS requires credit unions to pay

dividends or interest based on the full amount of principal in an account once
the member meets the minimum balance to earn dividends. Unless specified
otherwise, the word “interest”and “dividend” or “dividends”are
interchangeable.
The dividend rate is the annual rate the credit union pays on an account (not
reflecting compounding.) When a credit union pays dividends, it applies a
periodic dividend rate to an account balance. Dividends do not include the
absorption of expenses, forbearance in charging fees, non-dividend
membership benefits, extraordinary dividends, or the payment of bonuses. If a
credit union chooses to pay dividends for the use of funds, TIS mandates:
Page 19T-2
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TRUTH IN SAVINGS ACT APPENDIX 19T
Each day the credit union must pay dividends equal to at least 11365 (or
1/366 in a leap year) of the dividend rate on the full amount of principal in
the account. A credit union may apply a daily periodic rate greater than
1/365 of the dividend rate (e.g., a daily periodic rate of 1/360) as long as
the credit union applies that rate 365 days a year;
0 The credit union must calculate the account balance on which it pays
dividends using either:
- The daily balance method, which applies a daily periodic rate to the
full amount of principal in the account every day; or
- The average daily balance method, which applies a periodic rate to the
average daily balance (the sum of the full amount of principal in the
account for each day of the period, divided by the number of days in
the period);
0 Credit unions with a minimum balance requirement to earn dividends may

choose not to pay a dividend for those days when balances fall below the
required minimum. Credit unions using the average daily balance method
may choose not to pay a dividend if the average balance for the period falls
below the minimum. If a credit union imposes a minimum balance to earn
a dividend, it must use the same calculation method to determine whether
the member meets the minimum balance as it uses to calculate dividends.
If members would benefit, the credit union can use an additional method
to determine if the members meet the minimum balance requirement;
0 Credit unions must choose how often they will compound and credit
dividends. If previously disclosed in writing, credit unions may require
members that close accounts between crediting dates to forfeit accrued but
uncredited dividends; and
0 Dividends begin to accrue not later than the business day the funds are
deposited in an account, unless the credit union provides notice of a later
time in its policy disclosures under $606 of the Expedited Funds
Availability Act and Regulation CC. Once started, dividends must
continue to accrue until the member withdraws the funds. However, a
credit union need not pay dividends (1) during a grace period for
automatically renewable term share accounts if the member decides during
the grace period not to renew the account, or (2) after a nonautomatically
renewable term share account matures.
Page 19T-3
EXAMINER’S GUIDE
A term share account is a share certificate, interest-bearing certificate of

deposit account, or other account (e.g., club account) with a maturity of at
least seven days, and members may not make withdrawals for six days after
opening the account unless an early withdrawal penalty of at least seven days’
dividends on the amounts withdrawn exists.
Annual The following two terms describes the yield earned by members:
Percentage
Yields Annual percentage yield (APY), used for account disclosures and
advertising, measures the total amount of dividends paid on an account
based on the dividend rate and the frequency of compounding for a 365-
day period.
0 Annual percentage yield earned (APYE) reflects the relationship

between the amount of dividend actually earned and the average daily
balance in the account for the statement period or, in some cases, for a
period other than the statement period such as the dividend period.
General The written account disclosures must (1) reflect the legal obligation between
Disclosure the parties, (2) contain clear and conspicuous information so that members
Requirements may readily understand the terms of their accounts, and (3) present the
information in a form that the member or potential member can permanently
retain. Credit unions may deliver periodic statement disclosures in electronic
form if the member agrees to this form of delivery. A credit union may have a
separate disclosure for each account or it may combine TIS disclosures for
several accounts in a single document, such as a brochure for all savings
accounts.
Credit unions must use the following specific terminology for TIS:
0 “Annual percentage yield” in account disclosures and advertisements;

0 “Dividend rate” in account disclosures and advertisements (credit unions
may also use “annual percentage rate” in account disclosures in addition to
the term “dividend rate”); and
0 “Annual percentage yield earned” on periodic statements.
The credit union must show APY and APYE to two decimal places and
rounded to the nearest one-hundredth of one percent (.01%.) The same rule
Page 19T-4
-
applies to dividend rates, except that account disclosures may show the
dividend rate at more than two decimals.
TISA considers the APY or APYE accurate if it is within 1/20 of one

percentage point (.05%) above or below the actual percentage yield as
determined in Appendix A of Part 707. Credit unions may not intentionally
incorporate the tolerance as part of their calculations. There is no
corresponding tolerance for the accuracy of the dividend rate; it must be
precise.
Providing Credit unions must provide accurate account disclosures, before they open an
Account account or provide a service (when assessing a fee), whichever is earlier. If
Disclosures members do not open accounts in person, the credit union must mail or deliver
the account disclosures within 10 business days after opening the accounts.
Credit unions must also provide disclosures within a reasonable period of the
request (10 business days) for each account for which the member requests
information.
For member-requested dividend-bearing term share account (share certificate)

and interest-bearing account disclosures, the credit union must specie the
APY and interest rate offered within the most recent seven calendar days, that
the rate and yield are accurate as of the identified date, and must provide a
telephone number to obtain current rate information. For term share accounts,
the credit union may state maturity as either a term or a date.
For share (dividend-bearing) accounts other than term share accounts, the
credit union must disclose the dividend rate and APY that applied as of the
last dividend declaration date. If these rates can change, the credit union may
disclose the prospective dividend rate and APY in lieu of, or in addition to, the
rate and APY as of the last dividend declaration date.
Oral When credit unions respond orally to inquiries about rates, they must state the
Responses to APY as discussed above in the Providing Account Disclosures section and
Inquiries may state the dividend rate. If they state the dividend rate, they must do so as
discussed in the above section.
Page 19T-5
EXAMINER'S GUIDE
Content of Credit unions must disclose the following information in account disclosures
Account (as applicable):
Disclosures
Rate information:
- APYs and dividend rates using the terms "annual percentage yield" and
"dividend rate" (credit unions may disclose a periodic rate
corresponding to the dividend rate);
- Time period the dividend rate will remain in effect after a member
opens a fixed-rate account;
- Each dividend rate, along with corresponding APYs for each specified
balance level for tiered-rate accounts;
- A single composite APY, all dividend rates, and period of time the rate
will be in effect for each step for stepped-rate accounts (has two or
more dividend rates that take effect in succeeding periods and are
known at account opening); and
- Information on variable-rate accounts (those where the dividend rate
may change after the member opens the account, unless the credit
union contracts to give at least 30 calendar days advance written notice
of rate decreases.) The credit union must disclose the following
information:
i. A statement that the dividend rate and APY may change;

ii. The method by which the credit union determines the dividend
rate. If the credit union reserves the right to change rates and does
not tie changes to an index, it must disclose that rate changes are
within the credit union's discretion;
iii. Limitations on the amount the dividend rate may change; and
iv. The frequency with which the dividend rate may change. Credit
unions that reserve the right to change rates at any time must state
that fact.
0 Compounding and crediting information:
- The frequency with which the credit union compounds and credits
dividends (e.g., daily, monthly, quarterly, etc.);
- The dividend period (for dividend-bearing accounts); and
- The effect of closing an account when the account contract provides
that the credit union will not pay accrued but uncredited dividends if
Page 19T-6
the member closes the account before the credit union credits the
dividends.
0 Balance information:
- Any minimum balance requirements to:
i. Open an account;
ii. Avoid the imposition of fees; or
iii. Obtain the APY.
(A credit union must also describe how it determines the balances (ii)
and (iii)).
- The balance computation method (i.e., the daily or average daily

balance method) used to calculate dividends on the account;
- The par value of a share necessary to become a member and maintain
accounts at the credit union; and
- When dividends begin to accrue.
Fee information (amounts and types of all fees that may be assessed),
including:
- Maintenance fees;
- Fees related to deposits or withdrawals, whether by check or electronic
transfer;
- Fees for special account services (credit unions need not disclose fees
for services unrelated to accounts, e.g., money order fees, traveler
check fees, etc.); and
- Fees to open or close accounts.
0 Transaction information including:
- Limitations on the number or dollar amount of deposits to,

withdrawals from, or checks written on an account for any time period;
and
- When the member may not make withdrawals from or deposits to term
share accounts.
0 Term share information:
Page 19T-7
EXAMINER'S GUIDE
- Time requirements including the term (for generic disclosure requests),

otherwise, the credit union must state the maturity date;
- Early withdrawal penalties including how the credit union calculates
them and the conditions under which it assesses them;
- Withdrawal of dividends prior to maturity requirements (i.e., on a term
share account that compounds dividends, if a member may withdraw
accrued dividends prior to maturity, the credit union must disclose the
resulting reduction in account earnings.) The APY assumes that
dividends remain in the account until maturity. Credit unions that do
not compound dividends on an annual or more frequent basis, and that
require the dividend payouts at least annually, and that disclose the
APY in accordance with Section E of Appendix A, must state that
dividends cannot remain on account and that payout of dividends is
mandatory; and
- Renewal policies including:
i. Whether a term share account automatically renews at maturity;

and
ii. Whether the credit union provides a grace period and, if so, its
length. For nonautomatically renewable term share accounts, a
credit union must disclose whether it will pay dividends after
maturity if the member does not renew the account.
0 Bonus information:
- The amount and type of bonuses the credit union offers;

- The timeframe in which the credit union will pay the bonus; and
- The minimum balance or time requirements necessary to obtain the
bonus.
Nature of Dividends (i.e., credit union pays dividends at the end of a

dividend period from current income and available earnings after required
reserve transfers.) Credit unions need not make this dividend statement for
dividend-bearing term share accounts or interest-bearing accounts.
However, if the credit union requires a member to open a share account in
order to open a dividend-bearing term share or interest-bearing account,
the credit union must disclose the "nature of dividends" for the share
account. The credit union need not make the disclosure in advertising and
oral responses to rate inquiries.
Page 19T-8
Change In Credit unions must send a written notice 30 calendar days before the effective
Term Notices date of a change of the term for an account that requires disclosure, if that
change may reduce the APY or adversely affect members. No requirement for
notices exists under the following circumstances: (1) if the rate changes on a
variable-rate account, (2) if the terms change for term share accounts with a
maturity of 3 1 days or less, or (3) if the fees (or the credit union's mark-up) for
share draft printing increase.
Notices for TIS requires the following disclosures for term share accounts that
Maturing Term automatically renew and those that do not renew automatically:
Share
Accounts 0 Automatically renewable:
- Credit unions with automatically renewable term share accounts
having maturities of more than one year must provide the same
account disclosures that they would provide to a member opening a
new account, along with the date the existing account matures. If credit
unions do not know the APY and dividend rate when they send the
account disclosures, they may explain that they do not have this
information available along with the date when they will have the yield
and rate available and a telephone number where members can obtain
the new yield and rate. Credit unions must send disclosures either 30
calendar days before the scheduled maturity date, or 20 calendar days
before the end of a grace period if the grace period is at least five
calendar days. Therefore, if the credit union has at least a 5-day grace
period, it may send the disclosures 15 calendar days before the
maturity date;
- Credit unions with automatically renewable term share accounts

having maturities of more than one month but less than or equal to one
year must either (1) provide account disclosures identical to the
automatically renewable term share accounts with maturities of more
than one year; or (2) provide abbreviated disclosures that include the
date the existing account matures, the new maturity date (if the account
is renewed), the dividend rate and the APY for the new account (if
known), along with any differences in the terms of the new account as
compared to the terms of the existing account. Credit unions must
provide these disclosures (or the disclosure required if the dividend
rate and the APY are unknown) within the same timeframes as those
Page 19T-9
EXAMINER'S GUIDE
for automatically renewable term share accounts with a maturity of

longer than one year; and
Nonautomatically renewable:
- Credit unions with nonautomatically renewable term share accounts
having terms longer than one year must send a notice 10 calendar days
before maturity stating the maturity date of the existing account and
whether the credit union will pay dividends after maturity. If renewed,
credit unions must provide new account disclosures; and
- Credit unions with nonautomatically renewable term share accounts of

one year or less need not provide notice prior or subsequent to
maturity. Credit unions must provide new account disclosures on
renewed accounts.
Notices for Maturing Term Share Accounts
Automatically Renewable Nonautomatically Renewable

(Rollover) Term Share Accounts (Nonrollover) Term Share Accounts
1 month No advance notice required. No notice required.
or less New disclosures if renewed.
(31 days)
Greater than m: No notice required.
1 month but 1 (A) 30 (calendar) days before maturity;
year or less or
(b) 20 (calendar) days before end of
grace period, if a grace period of at least
5 (calendar) days is provided.
Content:
Dividend rate and APY for new account New account disclosure if renewed
(or fact that rates have not been
determined, when they will be, and
telephone number to call for rates), and
&:
(A) maturity date of existing and new
accounts, and any change in terms; or
(B) full disclosures for account
($707.4(b)) and maturity date for
existing account.
Greater than m: m:
1 year Same as for accounts greater than 1 I0 (calendar) days before maturity.
month but I year or less.
Content: Content:
Full disclosures for account ($707.4(b)) Maturity date, and whether or not
dividends will be paid after maturity.
and maturity date for existing account. New disclosures if renewed.
Illustration 19T-1
Page 19T-10
-
Periodic TIS does not require credit unions to send periodic statements (those with
Statement account information provided on a regular basis four or more times a year),
Disclosures but if the credit union does provide a statement, it must include certain
information.
Credit unions may deliver periodic statement disclosures in electronic form if

the member agrees to that form of delivery. State law determines whether the
parties have an agreement. The credit unions must provide the periodic
statements in a clear and conspicuous form that the member can display as
visual text and can retain. Credit unions that provide periodic statements must
disclose the following information for the statement period, as applicable:
APYE:
- Credit unions must disclose the "annual percentage yield earned"
(computed according to Part 707, Appendix A, Part 11), using that
term. The APYE is an annualized rate that shows the actual dollar
amount of dividends earned (either accrued g paid and credited) on an
account as a percentage of the average daily balance in the account for
the actual number of days in the period. Credit unions should clarify
their definition of "earned". Credit unions that calculate and credit
dividends for a period other than the statement period (e.g., the
dividend period) may calculate and disclose the APYE and amount of
dividends earned based on that period rather than the statement period.
- If credit unions provide periodic statements more frequently than the

dividend period, only the statements covering the period in which
dividends (not interest) are credited must include the amount of
dividends earned and the APYE. For interest-bearing accounts, credit
unions must base accrued but uncredited interest on the statement
period, unless they calculate interest using the average daily balance
method and the average daily balance period is less frequent than the
statement period. (For purposes of determining the APYE, credit
unions compute the average daily balance since usually they already
determined the dividends earned and the number of days in the period.)
Conversely, if the dividend period is more frequent than the statement
period, the credit union may either disclose a single dividend rate and
APYE g disclose three dividends earned and three APYEs, one for
each dividend period, as long as the credit union states the number of
days (or beginning and ending dates) in each dividend period that
varies from the statement period.
Page 19T-11
EXAMINER'S GUIDE
0 Amount of dividends:
- Credit unions must disclose the dollar amount of dividends credited
and interest earned (accrued or paid and credited.) They may base
dividend disclosure on the statement period or another period (e.g.,
dividend period); however, they must base interest on the statement
period unless they use the average daily balance method to calculate
interest and the average daily balance period is not as frequent as the
statement period. The dollar amount of the dividend disclosed and the
APYE must reflect the same period. Credit unions must disclose dollar
amounts of extraordinary or bonus dividends earned during the period
separately.
Fees:
- Credit unions must disclose fees (see NCUA Rules and Regulations
§707.4(b)(4)) that they have actually debited from the account during
the period. They must itemize the fees by dollar amount and type and
may either group the fees by type or individually itemize the fees.
0 Length of period:
- Credit unions must disclose the total number of days in the statement
period. Alternatively, they may state beginning and ending dates of the
statement period as long as they make clear whether they included both
of these days in the period. If credit unions disclose the dollar amount
of dividends earned based on a period other than the statement period,
they must disclose the length of that period as well.
0 Special Formula:
- Credit unions that provide statements more frequently than the period
for which they compound dividends must use the special APYE
formula in Part 707, Appendix A, Part I1 B.
Advertising Credit unions must exercise care in advertisements for share and deposit
accounts. An advertisement is any commercial message appearing in any
medium (e.g., newspaper, television, lobby boards, and telephone response
machines) if it directly or indirectly promotes the availability of, or deposit in,
an account.
TIS prohibits misleading or inaccurate statements in advertisements (e.g., TIS

does not allow the term "profit" in ads for interest-bearing accounts, but does
Page 19T-12
-
allow it in ads for dividend-bearing accounts, since dividends are a return on a

member's share investment.) TIS does not allow the term "free" or '!no-cost" if
the credit union imposes any maintenance or activity fee on the account.
However, since credit unions usually consider automated teller machines
(ATMs) a service that does not require a user to open or maintain an account,
ATM fees associated with such accounts would not restrict a credit union from
advertising the accounts as "free". Credit unions may advertise free
transactions at ATMs as "free"; however, the credit unions must disclose time
limits placed on a free service.
If credit unions advertise a rate, they must express it using the term "annual
percentage yield" (abbreviated as "APY") if the term is spelled in full at least
once in the advertisement. Credit unions may state no other rate, except the
"dividend rate" that corresponds to the advertised APY.
Credit unions trigger the following additional disclosure requirements, as

applicable, if advertisements (not exempt under §707.8(e)) display an APY:
Variable rates;
Time period - how long the credit union will offer advertised APYs (e.g.,
"from March 7 through March 13" or "annual percentage yield effective as
of March 7");
Accuracy of APY - for dividend-bearing accounts other than term share
accounts, a statement that APY is accurate as of the last declaration date
or, if inaccurate, the prospective APY;
Minimum balances required to obtain the advertised APY;
Minimum opening deposit;
Fees that could reduce earnings on the account;
Term share accounts - specifying the term (e.g., three months) and early
withdrawal penalties;
Advertisement - if advertisement states that APY equals dividend rate for
noncompounding multi-year account, it must state that dividend payouts
are mandatory;
Tiered-rate accounts - including all APYs (including APY ranges), all
dividend rates, and any minimum balance required to obtain the APYs for
each tier; and
Stepped-rate accounts - these accounts stating a dividend rate must state
all dividend rates and the time period for each;
Bonus - if a bonus is displayed in an advertisement, it must disclose (1)
the APY, (2) time restrictions to obtain the bonus, (3) when the credit
Page 19T-13
EXAMINER'S GUIDE
union will provide the bonus, and (4) required minimum balances
necessary to obtain the bonus.
Exemptions §707.8(e) of NCUA's Rules and Regulations permits abbreviated disclosure

from Some requirements for advertisements made through:
Advertising
Requirements Broadcast or electronic media (radio and television);
0 Outdoor media (billboards);
0 Telephone response machines;
0 Indoor signs (any sign that can reasonably be viewed only by a member
from outside the premises, such as lobby boards, is not subject to the
portions of 8707.8 regarding permissible rates, minimum balance,
bonuses, and certain media); and
Newsletters distributed only to existing members.
If the credit union discloses a rate of return or bonus on one of the first three
media listed above, the advertising requirements specify that, if applicable, the
credit union must:
State the rate of return as an "annual percentage yield", using that term at
least once;
State no rate other than the APY, except that the dividend rate may also be
stated;
State the minimum balance to earn the APY and the bonus;
State the time requirement to obtain the bonus;
State the term of the account (if a term share account);
State dividend payouts required, if applicable;
State all APYs and balance requirements for each tier for solicitations of
tier-rate accounts through telephone response machines; and
State the same disclosures required of a nonexempt media (if a tiered-rate
account.)
Credit union newsletters are exempt from many of the advertising

requirements if the credit union distributes the newsletter to existing members
only and does not intend it as a promotional piece for potential members.
Exercising care to reach only existing members demonstrates compliance with
the requirement for the exemption (e.g., credit unions should not leave
newsletters in the lunch room of the sponsor.)
Page 19T-14
If the credit union discloses a rate of return on an indoor sign or sends a

newsletter to existing members only, the advertising requirements specify that
the credit union state:
0 The rate as an "annual percentage yield", using that term at least once;
0 No other rate than the APY, except that the dividend rate may also be
stated; and
0 A statement that members should contact an employee for further
information about applicable fees and terms.
Effect on State TIS may preempt state law requirements that are inconsistent with the
Laws requirements of the TISA or NCUA's TIS regulation, but only to the extent of
the inconsistency. A state law is inconsistent if it requires a credit union to
make a disclosure or take action that federal law prohibits. Credit unions
desiring a preemption determination should request one from NCUA.
Record Credit unions must retain records of compliance with TIS for a minimum of
Retention two years after the date disclosures are required to be made or action is
required to be taken. Although they need not retain a copy of each disclosure,
credit unions desiring to establish compliance should (1) document established
procedures for providing the various disclosures, ( 2 ) follow the procedures,
and (3) retain sample disclosures for the types of accounts offered. Credit
unions must keep sufficient rate and balance information to enable examiners
to verify dividends paid on the account.
Acceptable records storage methods include microfiche, microfilm, magnetic

tape, or other methods capable of accurately retaining and reproducing
information (e.g., a computer file.) Credit unions need not retain disclosures or
advertisements in hard copy, as long as they can reconstruct required
disclosures or other records.
Failure to NCUA may enforce compliance of the Truth in Savings Act and Part 707
Comply under both the Truth in Savings Act and the Federal Credit Union Act.
Defenses If the evidence demonstrates that a violation was unintentional and resulted
fiom a bona fide error, a credit union may not be subject to civil liability for
Page 19T-15
EXAMINER’S GUIDE
violations. To avoid liability, a credit union must document that it had

instituted reasonable procedures to avoid inadvertent errors including clerical,
computer programming, and printing errors. An additional defense may
include the credit union’s reliance on the Official Staff Commentary or
interpretations. Credit unions cannot use errors of legal judgment as defenses;
however, they may avoid liability by notifying the account holders and making
adjustments within 60 days after discovering the violation.
Examination If necessary, examiners should:

Procedures Review the credit union’s TISA policies and procedures;
0 Determine the credit union has a detailed disclosure as required;
0 Determine the credit union accurately calculates the APY, dividends, and
APYE;
Determine whether the credit union provides initial disclosures as required;
Determine whether the credit union appropriately discloses the annual
percentage yield and the dividend rate;
Determine procedures are in place for staff to accurately respond to oral
account inquiries;
Determine whether the credit union notifies members of any adverse
changes at least 30 days before the change;
Determine whether periodic statements include clear and conspicuous
disclosure of:
- APYE;
- Amount of dividends earned;
- Amount and type of fees imposed;
- Time frame of the reporting period; and
Determine whether the share account advertisements, announcements,
internet web pages, or other solicitations avoid misleading or inaccurate
representations of share account terms;

management and, if material, in the examination report.
Page 19T-16
Chapter 20
REPORT WRITING
TABLE OF CONTENTS
REPORT WRITING ....................................................................................................... . 20. 1

Report Writing Objectives ................................................................................... 20-1
Overview............................................................................................................. . 20. 1
Components ........................................................................................................ .20.2
Scope Workbook...................................................................................... 20-3
Examiner Contact Information................................................................ .20.3
Examination Overview ............................................................................ 20-3
Document of Resolution .......................................................................... 20-4
Confidential Section................................................................................ .20.4
Supplementary Facts ................................................................................ 20-6
LUAs, NWRPs, and Revised Business Plans ........................................ ..20.7
Examiner's Findings................................................................................. 20-7
Possible Additional Actions................................................................................ .20.8
Workpapers ......................................................................................................... .20.8
APPENDIX 20A - AIRES Reports ................................................................................. 20A-1
ChaDter 20
REPORT WRITING
Report Communicate to the credit union officials the results of the
Writing examination, including an appropriate discussion of risk areas and
Objectives the required disclosure of CAMEL components and composite
ratings
0 Present for discussion and adoption (or revision) necessary plans
for correcting problems and reducing unacceptable risks
0 Prepare documented administrative record for NCUA
Overview The examination report is NCUA's official report to the credit union. It
serves as an important communication tool between the examiner, the
credit union, and NCUA. The examiner-in-charge obtains information
from the team members on areas they reviewed, prepares the report,
and delivers it to the board of directors at the conclusion of the
examination. The examiner should individualize the report for the
officials, who comprise the report's primary users and primary
audience.
Examiners should prioritize communicating with credit union officials

and management throughout the examination process. Nothing
presented at the joint conference, exit interview, or in the examination
report should surprise the officials. Examiners should set aside time
throughout the examination for discussion with management and
officials regarding developments and findings in the examination.
They may also provide the officials a draft copy of the report and give
the officials and management sufficient time to review it before the
joint conference or exit interview.
The examination report represents a written explanation of the risk

profile, significant financial conditions, trends, problems, agreements,
and guidance to officials. As such, it documents all significant items
identified during the examination and risk assessment. Examiners must
retain a copy of the official report, including all workpapers, schedules,
checklists, forms, and examiner-prepared notes used to support their
conclusions. Appendix 20A lists (1) a complete set of all AIRES
workpapers; (2) the minimum required workpapers the examiner must
Page 20-1
-
EXAMINER'S GUIDE
provide for regional management and quality control reviewers; and

(3) the minimum required output reports that the examiner must
provide in the examination report to the credit union.
COmPOnentS Examiners must complete the following required workpapers:
Scope Workbook,
0 Examination Contact Information,
Overview,
0 Document of Resolution (if applicable),
Confidential Section, and
0 Table of Contents.
The following required questionnaires represent performance of the

three minimum exam procedures:
0 5300 Review Questionnaire,

0 Supervisory Committee Audit and Verification Review
Questionnaire, and
Bank Secrecy Act Questionnaire.
Examiners will use the AIRES Table of Contents to organize the report
given to the officials and to document which workpapers they included
in the report.
Although these comprise the required workpapers, examiners must

document the areas they reviewed and the steps they performed during
the examination. This documentation will support the examiner's
findings and conclusions, and will serve as an administrative record.
Examiners will use their judgment to determine which workpapers
appropriately document the work they perform and which they will
include in the copy of the report to the credit union.
Examiners will provide the credit union copies of the Overview and
the Document of Resolution (if applicable). The credit union will not
receive a copy o f the Scope Workbook, Examination Contact
Information, or the Confidential Section. Examiners may provide the
credit union any schedules, findings, optional workpapers,
questionnaires, and examiner-designed workpapers to support their
Page 20-2
REPORT WRITING
conclusions and assist in gaining resolution to problems uncovered

during the examination or supervision process.
Additionally, some regional directors have separate agreements with

various state supervisory authorities (SSAs) on the completion of the
Compliance Violation Input Form and the Consumer Compliance
Checklists in state credit unions. Therefore, examiners should follow
regional instructions on such agreements.
Scope Workbook The Scope Development and Planning chapter of this Guide provides
guidance in completing the Scope Workbook.
Examiner Examiners use the Examiner Contact Information workpaper to update

Contact NCUA's database with certain information compiled during
Information examinations and supervision contacts. The data for this report flows
from the Contact and Problem Areas screens and the CAMEL
evaluation and Key Ratios worksheets.
Examination During each examination in federal credit unions, examiners will

Overview complete an Overview that, at a minimum, discloses the CAMEL
ratings, both component and composite. If no material risks exist, the
Overview normally will be brief.
Even though the CAMEL ratings constitute the only requirements of

the Overview, examiners will often use it to discuss and support their
review, analysis, and conclusions, and to put examination findings into
proper perspective. Examiners may also make appropriate comments
about risk assessment aspects of the examination scope. The depth and
complexity of the Overview will vary depending on the degree of
problems noted. To make the Overview as effective as possible in
relating the material results of the examination, examiners should
structure it to discuss the most critical risks first.
Examiners usually complete the Overview near the end of the

examination, according to regional timefiames. If examiners learn of
additional information at or after the joint conference that affects the
report's content, they may amend the Overview or comment on the
Page 20-3
EXAMINER'S GUIDE
matter in the Confidential Section. In state-chartered credit unions,

examiners should follow the disclosure policies of the respective state
supervisor. Generally, the agreement between the regional director and
state supervisor contains these disclosure policies.
Document of Examiners use the Document of Resolution to outline plans and

Resolution agreements reached with officials to reduce areas of unacceptable risk.
An area of unacceptable risk is one for which management does not
have the proper structure for identifying, measuring, monitoring,
controlling, and reporting risk. The Document of Resolution should
parallel the Overview (most critical to least critical risks); however, the
Document of Resolution will include persons responsible and
timeframes for correction.
Examiners should not address minor issues in the Document of

Resolution, but should discuss minor issues with management.
Examiners can document these minor issues using an optional AIRES
or examiner-prepared workpaper. They can provide these workpapers
informally to management for correction, but should not clutter the
formal report to the credit union with minor or immaterial issues. The
region's copy of the report should include workpapers provided to
management. These will be part of the administrative record.
Before the joint conference, examiners should strive to reach

agreements on corrective action the credit union needs to take. At
times, officials will not agree to a Document of Resolution. If this
occurs, the examiner should work with officials to develop alternative
solutions or give them additional time to develop acceptable plans of
their own. If they fail to do so within the agreed-upon timeframe, the
examiner should consider drafting a Regional Director Letter urging
officials to formulate an acceptable plan that recognizes and resolves
the problems.
In instances where the officials did not adopt the Document of

Resolution, the Confidential Section should explain why. The
following example documents an appropriate footnote to a Document
of Resolution not adopted:
Page 20-4
REPORT WRITING
These plans for action, although not approved by the credit union
officials, are recommended to correct the area of concern. The
officials have agreed to review the plans and to notify the Regional
Director, National Credit Union Administration, [enter
appropriate address), by Jenterdate), of the actions to be taken.
Examiners may, at their option, add the following wording to the

footnote:
If appropriate, the officials will submit alternate plans of action for

review.
In rare instances, the directors do not agree to the Document of

Resolution and do not offer alternate plans, or fail to do so within the
agreed upon timeframe. In these cases, the examiner should consider
the nature of the Document of Resolution and discuss the course of
action with the supervisory examiner following regional policy. When
the overall risk to the credit union so warrants, the examiner and
supervisory examiner may find it necessary to recommend
administrative action, again following regional policy.
When the examiner must repeat a Document of Resolution from a

previous examination because the officials failed to sufficiently correct
the area of concern, the examiner should emphasize the repeated
agreement. The examiner should place an asterisk beside the item and
footnote the lack of corrective action to draw management's attention
to the ongoing problem.
Confidential The Confidential Section is for NCUA's internal use only. Examiners
Section should comment briefly but completely enough to clearly reflect
actions taken during the examination. The Confidential Section should
reduce repetition by not repeating items covered in the Scope
Workbook, Overview, or other sections of the report, unless additional
information is needed. If not discussed elsewhere in the report, the
Confidential Section should state what formal actions the board took
and how the officials will handle major problems.
Examiners should also discuss agreements reached with officials apart

from the Document of Resolution. Of particular importance is an
explanation of what the examiner accomplished during discussions
with officials.
Page 20-5
EXAMINER'S GUIDE
The Confidential Section should document (1) whether the examiner

held a joint conference, (2) whether the officials requested the joint
conference (if Code 1 or 2), and (3) the attendees at the joint
conference or exit meeting. It may also document discussions with
management about correction of minor issues and should document
discussions regarding expansion into underserved areas. (See the Joint
Conferencemxit Meeting chapter for additional guidance.)
Examiners should cover pertinent matters of a private or restricted

nature, including personal opinions based on the examiner's
observations. However, the examiner should not make statements
based on gossip or hearsay. Situations exist when a court directs the
release of all or part of a particular Confidential Section. Further,
NCUA may release some parts of a Confidential Section in compliance
with a Freedom of Information Act request. The possibility of release
should not dissuade examiners from presenting necessary information;
however, examiners should maintain their professionalism and
objectivity when writing the Confidential Section.
Examples of material that examiners may cover in the Confidential

Section include the following:
0 Perspective on a new credit union's progress,

0 Comments on the attitudes and abilities of the officials,
0 Potential difficulties facing the credit union,
Plans for monitoring the credit union (i.e., on-going risk-focused
supervision,) and
0 Other appropriate topics.
Examiners should use the Confidential Section as extensively as

necessary but they should not clutter the section with inconsequential
or irrelevant facts and opinions.
Supplementary Examiners may use the Supplementary Facts to discuss material facts
Facts or situations not contained in other narrative sections of the
examination report (e.g., bond claims, discussion of fraud, progress on
Letters of Understanding and Agreement, progress on Net Worth
Restoration Plans, etc.). If there exists no need to prepare the
Page 20-6
REPORT WRITING
Supplementary Facts, examiners will not include the form with the
workpapers.
LUAS, NWRPS, The examiner may use either the Supplementary Facts or the
and Revised Overview to document management's progress in complying with
Business 'Ians outstanding Letters of Understanding and Agreement (LUAs), Net
Worth Restoration Plans (NWFWs), and Revised Business Plans.
Examiners may record the date the officials signed one of the above
agreements, and any subsequent revisions to the agreements.
Examiners should list each item of the agreement and document the
degree of compliance. In the rare event that NCUA publishes an LUA,
the examiner should contact the supervisory examiner before
discussing compliance with the terms of the LUA in the report.
Examiner's Examiners may use the optional Examiner's Findings workpaper to list
Findings material operating exceptions, violations of law or regulation, and
unsafe and unsound policies, practices, and procedures. Examiners
should not discuss minor, infrequent infractions in the Examiner's
Findings since they detract from the more important matters. As
previously discussed, other vehicles exist for documenting discussions
of minor concerns with management.
Examiners, at their discretion, may include the Examiner's Findings in

the Examination Report to the board of directors or they may provide
the workpaper to credit union management and not include it in the
report.
When identifjing a finding, the examiner should cite the specific

section of the FCU Act, FCU Bylaws, NCUA Rules and Regulations,
or other authority. In the event that the credit union violates more than
one of the above, the examiner should cite the highest authority.
Examiners should list exceptions noted during previous examinations

but not yet corrected under a heading similar to: "Findings Noted at
Previous Examination That Are Not Yet Corrected" or by placing an
asterisk next to the exception and footnoting it with similar wording.
Page 20-7
EXAMINER'S GUIDE
Possible Submittal of Periodic Reports. Under the risk-focused approach,

Additional examiners will supervise the credit union throughout the year. As
Actions part of that supervision, examiners may request that the credit
union mail them copies of the monthly financial reports,
delinquency reports, board minutes, etc. to monitor existing and
potential risks.
0 Regional Director Letters. In problem credit unions, regions

attempt to correct noted problems by sending Regional Director
Letters to the credit union in question. In severe cases, the letters
indicate that unless the credit union takes corrective action or
makes reasonable progress, NCUA may pursue administrative
action. The letter should cite the serious or persistent problems and
the unsafe or unsound practices that exist. The examiner should
follow regional policy for wording and processing of the letter. The
examiner should tailor the letter's contents to suit the needs of the
individual credit union.
0 Administrative Action. The Administrative Action chapter outlines

procedures for when the examiner believes that an administrative
action is necessary to correct financial or operational deficiencies.
- Scope Workbook
- Examiner Contact Information
- Examination Overview
- Document of Resolution
- SupplementaryFacts
- Examiner's Findings
- Confidential Section
- Table of Contents
Page 20-8
AIRES REPORTS - APPENDIX 20A
Legend:
J Minimum requirement for report to NCUA
JJ Minimum requirement for report to credit union
1 If violation noted is repetitive or substantial
2 Required, if applicable
3 Completed as set forth in agreements between individual SSA and regional
director
I General I I I I
I Examiner Contact Information I J I J I I
Compliance Violation Input Form I J1 I J1 I
Scone Workbook 1 4 1 4 1
I Credit Union Location Information
Review Considerations
Credit Union Update
I I I
Analyst Report Review
I Table of Contents
Final
I J I I J J I
i
I Executive Summarv I I I I
I Examination Overview I J I J 1/41
I CAMEL Rating Exdanation I I I I
Supplementary Facts
Document of Resolution J2 J2 JJ2
I I I I
Examiner Findi- --
Examiner Findings Abbreviations
Confidential Sectinn I J I J I
Projections
Two Minute Profitability Test
General Ledger
General Ledger Journal Adjustments
Operating Fee/Share Insurance
Risk-Based Net Worth
Page 20A-1
EXAMINER'S GUIDE
General Ledger (Continued)

Alternative Components for Risk-Based
Net Worth
Allowance for Loan Losses I I I I
GL - Cash on Hand
GL - Cash on Deposit
GL - Cash Equivalents 4
GL - Prepaid and Deferred Expenses I
GL - Land I
GL - Buildings I I I I
GL - Furniture and EauiDment I I I I
GL - Leasehold ImDrovements I I I I
GL - Leased Assets Under Capital Lease
GL - Other Real Estate Owned
GL - Accounts Payable
GL - Notes Payable
GL - Regular Reserves
GL - Appropriation for Non Conforming
Investments
GL - Miscellaneous Equity I I I
Loans
Share Trends I
Shares Greater Than $100,000
Shares Less Than $0
Asset Liability Management
IRR - Part A
IRR - Part B
IRR - Part C
IRR - Part D
Page 20A-2
17-4 Test (ALM Analvsis) I

I Pricing Table h u t (ALM Analvsis) I I I I
I IRR-PartA I I I I
I IRR-PartB
IRR - Part C
7
IRR - Part D I
Liquidity - Part A
Liquidity - Part B
Liquidity - Part C
BSA - Bank Secrecy Act J J
OFAC 3
I Securitv Program I I I I
IC - Cash
IC - cuso
IC - Financial Triggers
I IC - Management I I I I
IC - Money Orders & Travelers Checks
IC - Security
IC - Wire Transfers
Inv - Account Controls
Inv - Cash Forward
Inv - CDs
Inv - Controls
Inv - Fed Funds
~
Inv - IC - Optional
Inv - IRPS 98-2 Optional
Inv - Mutual Funds
Inv - Optional - IC
Tnv - Renurchase Transaction
Inv - Reverse Repurchase
Inv - SBA
Inv - Securities Lending
Page 20A-3
EXAMINER'S GUIDE
Questionnaires (Continued)
Ln - Agricultural
Ln - ARM
Ln - Business Loans
Ln - Collection Program
Ln - Construction
Ln - Controls 3
Ln - Credit Cards IC 3
I Ln - Credit Practices Rule I 1 3 1 I
Ln - FHA-Real Estate 3
Ln - FDPA-Flood Disaster Protection Act 3
Ln - Home Equity
Ln - HOPA-Homeowners Protection Act 3
Ln - Indirect Lending 3
Ln - Leasing-IC 3
Ln - Leasing-IC 3
Ln - Lines of Credit-IC 3 1
I Ln - ODtionaI IC I 1 3 1 I
Ln - Real Estate-IC 3
Ln - Reg B-Equal Credit Opportunity 3
Ln - Reg B-Real Estate 3
Ln - Reg C-HMDA 3
Ln - Reg M - Leasing 3
Ln -Reg Z-Closed End Credit 3
Ln - Reg Z-HELOCs 3
Ln - Reg Z-Open End and Credit Cards 3
Ln - Reg Z-Variable RE Loans 3
I Ln - Reg Z-General I 1 3 1 I
Ln - Reg Z-Closed End Credit 3
Ln - RESPA 3 I
Sh - Optional-IC
Sh - Reg CC-Expedited Funds Avail. 3
Sh - Reg D - Reserve Requirements 3
Sh - Reg E - Electronic Funds Transfer 3
Page 20A-4
Questionnaires (Continued)
Sh - Share Drafts-IC
Sh - TISA-Truth in Savings Act 3
NOTE: In order to complete the required reports, examiners must complete the required
inputs, all color-coded yellow.
At the examiners’ option, they may also provide to the credit union any reconciliation
workpapers, questionnaires, and examiner-designed workpapers as needed to assist in
gaining resolution to problems.
Agreements between the SSA and the regional director may permit variations of these
reports. SSAs may prescribe additional examination elements which are peculiar to
their states.
Page 20A-5
Chapter 21
JOINT CONFERENCE AND EXIT MEETING

TABLE OF CONTENTS
JOINT CONFERENCE AND EXIT MEETING............................................................. 21 .1

Examination Objectives....................................................................................... 21.1
Joint Conference .................................................................................................. 21.1
Exit Meeting......................................................................................................... 21-2
Joint ConferenceExit Meeting Agenda ............................................................... 21-3
Joint ConferenceExit Meeting Preparation......................................................... 21-4
Conducting the Joint Conference ......................................................................... 21-4
Other Persons Present .......................................................................................... 21-6
Chapter 21
JOINT CONFERENCE AND EXIT MEETING

Establish an open forum for discussion of items of interest or
Examination concern
Objectives Convey the results of the examination to the officials and senior
management
Reach agreements on plans of action and timeframes to reduce
levels of unacceptable risk
Joint A joint conference is a meeting of the examiners and a sufficient

Conference number (quorum) of the board of directors to conduct official credit
union business. A joint conference provides the examiner the
opportunity to reach agreements with the board that they will take
appropriate action for reducing levels of unwarranted risk in the credit
union. Examiners rely on the joint conference and the examination
report to convey concerns about the credit union’s operation and
persuade management to take appropriate steps to implement
necessary corrective action. The examination report provides the
officials with documentation of conclusions reached at the joint
conference and other problems noted during the examination.
Examiners should prioritize communicating with credit union officials

and management throughout the examination process. Nothing
presented at the joint conference, exit interview, or in the examination
report should catch the officials by surprise. Examiners should set
aside time periodically to discuss with management and officials
developments in the examination. They may also provide a draft copy
of the report and give the officials and management sufficient time to
review it before the joint conference or exit interview.
Examiners must hold a joint conference at the end of every

examination for a credit union coded CAMEL 3,4, or 5. Additionally,
examiners will hold a joint conference in a Code 1 or 2 credit union if
the credit union board so requests. Otherwise, the examiner will hold
an exit meeting, rather than a joint conference meeting, unless
substantive concerns exist or if the examiner determines the need for a
communication forum. In state-chartered credit unions, the agreement
Page 21-1
EXAMINER'S GUIDE
between the region and the state usually governs the procedures for a
joint conference (refer to the FISCU chapter for more specific
information.)
Examiners should inform key officials in credit unions with probable

codes of CAMEL 1 or 2 early in the examination process that they may
request a joint conference. The examiner may invite the credit
committee, supervisory committee, and key staff to attend the joint
conference; however, as a courtesy, the examiner may want to discuss
whom to invite with the board chairperson before extending
invitations.
When the likelihood of holding a joint conference is high, the

examiner-in-charge should meet with the president or chairman as
early as possible during the examination to make necessary
arrangements. The examiner should emphasize the importance of
having a quorum of the board of directors in attendance. If the
examiner learns that a quorum cannot or will not attend, or encounters
problems that may extend the examination time, the examiner should
reschedule the joint conference.
Examiners should endeavor to make the joint conference constructive,

and conduct it in a business-like manner that promotes clear,
understandable communication with the officials. Requesting the
officials prepare minutes of the joint conference will avoid
misunderstandings. Credit unions often use tape recorders to record
their meetings. The officials usually ask for the examiner's
concurrence before taping the joint conference, a request to which the
examiner normally agrees. However, the examiner may request a copy
of the tape or a transcript.
When examiners do not expect to hold a joint conference, they should

make certain the officials understand they may request a joint
conference at the conclusion of the examination. In the event no joint
conference will occur, examiners should make every effort to have at
least one volunteer official present at the exit meeting.
Exit Meeting An exit meeting differs from a joint conference in that an exit meeting
does not require a quorum of the board attend. Generally, attendance at
Page 21-2
JOINT CONFERENCE & EXIT MEETING
an exit meeting consists of top management, key staff and possibly one
or more officials. Without a quorum of the board in attendance,
binding action cannot take place at an exit meeting. Examiners must
hold an exit meeting and/or a joint conference at the end of every
examination; however, Code 1 or 2 credit unions require only an exit
meeting, not a joint conference.
The examiner can determine the format and structure of the exit
meeting, which need not require the same degree of formality as a joint
conference. For example, before a joint conference, the EIC will
provide a preliminary review of the examination results to key staff
and possibly some officials. This gives management the opportunity to
discuss their concerns and any aspect of the examination (e.g., risk
profile, recommendations, findings, loan exceptions.) The examiner
can use information gathered from this meeting to prepare for the joint
conference and finalize the exam report.
At an exit meeting, the examiner normally discusses the following:
0 Current and potential risk profile of the credit union;

0 Examination findings (normally, fairly minor in nature);
Needed corrections; and
0 Any necessary action that management must take to the next board
meeting, with the agreement that management will notify the
examiner of the actions taken.
Joint Examiners should conduct both joint conferences and exit meetings in
Conference/ a clear, concise, and orderly manner. An agenda helps examiners keep
Exit Meeting their meetings focused and organize their presentations to ensure
Agenda coverage of pertinent data in a logical order. It assists the examiners in
differentiating material items from nonessential ones, and allows them
to concentrate on topics of most importance. An agenda also provides
documentation of topics discussed. Although an agenda is
recommended for every meeting, some examiners may forgo preparing
an agenda for an exit meeting in a credit union with no, or very minor,
concerns.
In cases of a team examination, the EIC may ask the team member
most familiar with a specific problem area to attend the meeting. This
Page 21-3
EXAMINER'S GUIDE
team member can discuss or answer questions that may arise

concerning that portion of the examination.
Joint During the course of each examination, examiners will discuss the
Conference/ credit union's risk profile, problems, and recommended solutions with
Exit Meeting management or key officials. This discussion serves to elicit their
Preparation cooperation and agreement as well as eliminate or reduce potential
conflicts that may occur at the joint conference. To maximize the
meeting's effectiveness, the EIC should resolve minor problems with
management before the exit meeting.
Before a joint conference, examiners should also develop with

management and key officials initial plans for corrective action that the
credit union will take to correct material problems noted in the
examination. The officials then need time to read, discuss, and
understand what the Document of Resolution means and the effect it
will have on the credit union. Examiners may minimize conflicts if
management and officials agree to plans of action before the joint
conference.
Conducting The effectiveness of the joint conference directly relates to successful

the Joint communication and examiner credibility. Examiners enhance their
Conference credibility when their conduct remains dignified, professional, and
objective. They should keep in mind the volunteer status of most
officials, who often have differing backgrounds and skills. Examiners
should provide the officials encouragement as well as constructive
criticism. The examiner should discuss major points and present the
information needed to enact corrective action.
Examiners may incorporate the following guidelines to help effectively

plan and conduct a joint conference:
0 Establish rapport with officials early in the joint conference. Let

attendees know that everyone present has the common goal of serving
the best interests of credit union members;
0 Compliment the officials for specific achievements and for their

volunteer time, if appropriate;
Page 21-4
JOINT CONFERENCE & EXIT MEETING
0 Encourage two-way communications. Invite the officials to

participate freely in the discussions. Ask questions frequently to
ascertain the officials’ understanding of the information presented; and
Present material in a clear, concise, positive and logical manner.
Examiners should not dictate credit union policy, but rather should
lead and persuade officials to proper action. Examiners may find that
using a “working copy” of the Document of Resolution, which was
previously discussed with management, promotes better understanding
and discussion at the joint conference. Key officials and staff will more
likely “buy into” and implement plans that they have a part in
developing. The willingness of the examiner to adjust or revise
recommendations during the joint conference can directly affect the
plan’s effectiveness.
If the board adopts the proposed Document of Resolution, the

examiner may present the formal copy of the examination report to the
chairman of the board at the joint conference. If the proposed
Document of Resolution changes, the examiner should arrange to
either deliver the formal report to the chairman or mail it upon
completion.
If the examiner and credit union do not reach agreement for needed
corrective action during the joint conference, the examiner should give
the officials a reasonable amount of additional time after the joint
conference to discuss the Document of Resolution and develop an
alternate plan of action. In this situation, the examiner should footnote
the Document of Resolution to require that officials present the
examiner with the board-developed plans of action, usually within 30
days after the joint conference.
If the officials recommend a reasonable alternative method of

resolving a problem, examiners should give strong consideration to
accepting the recommendation. After reviewing the board’s plan, the
examiner should notify the board as to its acceptability. An
unacceptable alternative plan of action may require the examiner to
schedule another meeting with the board.
Page 21-5
EXAMINER'S GUIDE
The examiner should obtain firm commitments from the officials for
carrying out the plans of action. The board minutes should record
agreements, disagreements, and promises. The examiner should review
all the agreements reached with officials at the conclusion of the
conference.
The Confidential Section of the examination report provides examiners

a place to record the details of the meeting, including whether
expansion into underserved areas was discussed. The examiner should
discuss the opportunity to expand credit union service to underserved
communities in certain credit unions identified for such possible
expansion by the region, the supervisory examiner, or the examiner.
When meeting with officials of the credit union, either at the joint
conference or exit interview, the examiner must state clearly that the
discussion regarding increasing credit union service to underserved
communities is not part of the examination.
Other Since examiners must maintain confidentiality regarding the matters

Persons discussed at the joint conference, they may prefer not having persons
Present other than credit union officials and employees present. However,
officials may wish to invite other persons. When this occurs, the
examiner should advise all officials that they must take full
responsibility for disclosure of any confidential information that may
result from the presence of outsiders. If any official objects to an
outsider and the participants cannot resolve the issue, the examiner
should postpone the meeting until a later date.
In those rare instances when examiners object to the attendance of any

outside individual, they should consult their supervisory examiners for
guidance. If the supervisory examiner concurs with the examiner, the
examiner should review the situation with the board chairman. If the
chairman cannot or will not resolve the problem, the examiner should
reschedule the meeting and prepare a memorandum outlining the
problems. Determining in advance who will attend the joint conference
will usually avoid such conflict.
Page 21-6
Chapter 22
EXAMINATION EVALUATION AND REVIEW
POLICY
TABLE OF CONTENTS
EXAMINATION EVALUATION AND REVIEW POLICY ....................................... ..22.1

Examination Evaluation and Review Objectives................................................. 22-1
Associated Risks ................................................................................................. . 22. 1
Overview............................................................................................................. . 22. 1
Minimum Standards.............................................................................................2 2-2
Supervisory Examiner Evaluations......................................................... .22-2
DOS Reviews ........................................................................................... 22-3
Selecting Reports for Evaluation and Review ........................................ .22-3
Independent Review and Feedback ......................................................... .22-4
DOS Review ........................................................................................................ 22-4
Risk Identification ................................................................................... .22-5
Scope Development ................................................................................ .22-5
Proper Solutions....................................................................................... 22-6
Continuing SupervisiodExamination Plans ........................................... .22-7
Comments ............................................................................................... .22-7
SE Evaluation....................................................................................................... 22-7
Risk Identification.................................................................................... 22-7
Scope Development and Resource Allocation........................................ .22-8
Proper Solutions...................................................................................... .22-9
Report Form .............................................................................................. 2-9
Continuing SupervisionExamination Plans ........................................... .22- 10
Comments ............................................................................................... .22- 10
SE Evaluation Summary ..................................................................................... .22- 10
APPENDIX 22A - DOS Review and SE Evaluation Forms ........................................... 22A-1
APPENDIX 22B - State Credit Union Report Reviews .................................................. 22B-1
ATTACHMENT 22.1 - State Examination Report Review Summary ............... .A22.1
Chapter 22
EXAMINATION EVALUATION AND REVIEW POLICY

Examination Communicate consistent feedback regarding the overall quality of
EvaIuat ion examiner work in a timely manner
and Review 0 Measure the quality and effectiveness of NCUA’s examination and
Objectives supervision program by assessing the quality of examiner problem
identification, recommendations for resolution and risk mitigation,
and effectiveness of communication with officials
0 Provide feedback for improving the examination and supervision
program to management and the examiner
Associated Although the associated risks in this chapter do not apply to the
Risks examination evaluations and reviews, the quality of the examination
report can cause risk to the National Credit Union Share Insurance
Fund (NCUSIF.)
Overview For purposes of staff development and quality control, NCUA

evaluates and reviews examination reports. The process occurs at two
levels:
0 Supervisory examiners in the field evaluate all of the examiners’

work as part of the examiner’s development and overall appraisal;
and
Division of supervision (DOS) analysts perform a quality control
function, and as such, limit their review to the written reports.
Supervisory examiners have responsibility for developing staff and

ensuring the effectiveness of the examination and supervision
program. To meet these responsibilities, they encourage the district
examiners to perform high quality examinations and supervision. The
Supervisory Examiner (SE) Evaluation commends the examiners for
high quality work, provides guidance to examiners, and informs
examiners of needed improvements in their work.
Page 22-1
EXAMINER’S GUIDE
DOS analysts review reports to identify existing or emerging trends,

common or frequently occurring findings, and systemic risk factors.
DOS can further observe trends within the credit unions (e.g.,
increases in member business loans, decreases in net worth) and trends
in the examination process (e.g., decrease in consumer compliance
reviews, misinterpretation of ALLL criteria.)
After DOS identifies and analyzes region- or area-wide findings,

trends, and risks, they communicate resulting information as
appropriate. Sharing of this information in a timely manner will enable
NCUA to determine the extent of the situation under review, monitor it
for further developments, and take action when necessary.
The “Selecting Reports for Evaluation and Review” section of this

chapter sets forth the national standard minimum criteria for reports
requiring an SE Evaluation or a DOS Review. The regional office may
adopt additional criteria thereby increasing reports they review to
further assure quality control or to meet other regional objectives.
Minimum All regions adhere to the following minimum standards for evaluations
Standards and reviews, presented in priority order. Regions may add standards
according to their needs.
Supervisory SE Evaluations serve as the basis for annual performance appraisals

Examiner and staff development. These evaluations should determine the
Evaluations following:
0 Examiners receive consistent, prompt feedback regarding the

quality of their work, including the strengths, weaknesses, and
suggestions for improving performance;
0 Examiners prepare an appropriate and effective scope and report

that adequately addresses risk, identifies problems, and makes
sound recommendations to resolve major problems within
acceptable time frames;
0 Examiners have written a report that stands alone and documents a

complete administrative record of the examination contact; and
Page 22-2
Examiners minimize NCUSIF losses through adequate

identification and resolution of problems.
DOS DOS Reviews focus on quality control and should address whether the
Reviews report:
Addresses risk through an appropriate and effective scope;
Focuses on results and includes plans for correcting problems

promptly;
Addresses negative trends and includes sound recommendations to

resolve major problems within acceptable time frames;
Complies with uniform examination, insurance review, and

supervision standards;
Presents a stand-alone document of the examination contact; and
Provides a complete administrative record of the examination

contact.
Selecting Supervisory examiners select at least five reports each year from each
Reports for examiner for formal evaluation. They should make every effort to
Evaluation and select the reports evenly throughout the year. When reviewing a report
Review that addresses a specific risk area well, the supervisory examiner may
determine that other examiners could benefit from the information
presented and methods outlined in the report. They may choose to
share this information for continuing staff development.
DOS, at a minimum, reviews reports meeting the following criteria:
0 All credit unions coded CAMEL 4 or 5 with assets greater than

$100,000;
All credit unions coded CAMEL 3 with assets greater than $50
million;
Page 22-3
EXAMINER'S GUIDE
0 All credit unions coded CAMEL 3 for longer than 36 months and
with assets greater than $5 million;
All credit unions with assets greater than $250 million; and
0 A selected sample of examinations and supervision contacts

determined by the regional director.
NCUA's reviews of federally insured state-chartered credit unions

(FISCUs) include at a minimum:
0 Insurance reviews performed independently by NCUA, including

supervision contacts designated by the regional director, using the
above criteria; and
0 Joint NCUA insurance review and state supervisory authority

(SSA) examination reports, including supervision contact reviews
designated by the regional director, using the above criteria.
Independent The supervisory examiner and DOS will conduct the evaluation and
Review and review processes independently. Both supervisory examiners and DOS
Feedback will complete and disseminate their evaluations and reviews within 30
days of the report upload. Regional policy determines whether the
region will release DOS Reviews to examiners.
Each region will develop its own policy to identify and resolve
material differences between DOS Reviews and SE Evaluations.
DOS Review The DOS Review will address the following:
1. Risk Identification;
2. Scope Development;
3. Proper Solutions;
4. Continuing SupervisiodExamination Plans; and
5. Comments.
Appendix 22A contains a sample form for a DOS Review. This form
contains the minimum elements regional office staff must include in
Page 22-4
their reviews. In addition to these required elements, each regional

director has the discretion to add other elements to these standard
criteria and use whatever format best fulfills regional needs.
Risk Risk identification is the recognition of significant problems through

Identification the collection, analysis, and verification of data. The Scope Workbook
and report will address and document material risks. The DOS review
will determine whether the report:
Properly assessed and appropriately rated risks (low, moderate, or

high) from the seven major risk areas (strategic, interest rate,
credit, liquidity, transaction, compliance, and reputation) and
reasonably determined the direction of the risks (increasing,
decreasing, or unchanged);
Identified and discussed areas with high or increasing risk

(moderate or high risk rating) including (1) the underlying cause;
(2) the problem’s severity, duration, and effect on the credit
union’s financial condition; and (3) deficiencies in policies,
processes, personnel, and control systems (refer to the Risk-
Focused Program chapter);
0 Identified and discussed material negative financial trends (e.g.,

key ratios, loan analysis, liquidity and funds management, shares
and deposits, capital evaluation, etc.);
0 Supported conclusions using the Total Analysis Process (TAP)

considering both quantitative and qualitative data;
0 Stated clearly that credit union officials acknowledged or refused

to acknowledge the existence of risks, problems, and weaknesses;
and
0 Supported CAMEL ratings consistent with risk ratings and in

accordance with current NCUA guidance.
Scope Scope development involves the process of evaluating the potential for
Development loss, and building examination procedures to review risk areas.
Page 22-5
EXAMINER'S GUIDE
Examiners require proficiency in developing the scope when

performing a risk-focused examination. Regional office staff assesses
whether the Scope Workbook:
0 Contained a preliminary risk assessment using historical

examination information, current financial data, 5300 data (risk
management reports and Financial Performance Reports [FPRs]),
and local economic factors;
Included modifications to the preliminary scope based on

examination analysis, unforeseen issues, and emerging problems;
and
0 Documented sufficient examination procedures used to evaluate

the risk areas usingprocess (e.g., review of policies and
procedures) and transactional procedures to ensure high-risk areas
received in-depth review and low-risk areas only a limited review.
Proper The report's effectiveness depends on the development and

Solutions communication of proper resolutions for the risks and problems
identified both during the scope development and the examination.
The analyst will evaluate the recommendations for problem resolution,
timeliness, and effectiveness. The DOS Review will include an
analysis of whether:
0 The Overview:
- Summarizes the risk profile, conditions, problems, and
probable effect of problems on operations and financial
condition; and
- Documents the plan for handling severe or persistent problems
clearly and provides information to officials concerning
consequences of inadequate action if management does not
correct noted problems by the next contact;
0 The Document of Resolution:

- Contains reasonable, effective, and timely corrective action
plans.
Page 22-6
Continuing Regional analysts will determine whether the Scope Workbook focuses
Supervision/ on continuing supervision and/or monitoring the financial condition of
Examination the credit union and existing and potential material risks.
Plans
Comments Regional office staff will use the Comments section of the DOS
Review for items that do not fall under the other criteria as explained
above.
SE Evaluation The SE Evaluation will address the following:
1. Risk Identification;
2. Scope DevelopmentResource Allocation;
3. Proper Solutions;
4. Form;
5. Continuing SupervisiodExamination Plans; and
6. Comments.
Appendix 22A contains a sample form for an SE Evaluation. This

form contains the minimum elements supervisory examiners must
include in their evaluations. Each regional director has the discretion to
add to these standard criteria and use whatever format best hlfills
regional needs.
Risk Risk identification involves comparing the scope to the examiner’s

Identification analysis in the narrative sections of the report. The supervisory
examiner determines whether the examiner:
Properly identified, assessed, and rated risks (low, moderate, or

high) from the seven major risk areas (strategic, interest rate,
credit, liquidity, transaction, compliance, and reputation) and
reasonably determined the direction of the risks (increasing,
decreasing, or unchanged) using appropriate workpapers;
0 Used the Total Analysis Process (TAP) to consider both

quantitative and qualitative data, weigh relative importance of data,
check accuracy, and reach and support valid conclusions;
Page 22-7
EXAMINER’S GUIDE
0 Adequately discussed major areas of risk (moderate or high risk

rating) including (1) the underlying cause; (2) the problem’s
severity, duration, and effect on the credit union’s financial
condition; and (3) material deficiencies in policies, processes,
personnel, and control systems (refer to the Risk-Focused Program
and Report Writing chapters);
0 Stated that credit union officials acknowledge or refuse to

acknowledge the existence of risks, problems, and weaknesses;
0 Assigned CAMEL ratings consistent with risk ratings and in

accordance with current NCUA guidance.
Scope The SE Evaluation will address the appropriateness of the scope and
Development and assess the examination process for the efficient use of resources.
Resource When evaluating scope development, the supervisory examiner
Allocation
considers whether the examiner:
Performed and documented a preliminary risk assessment using

historical examination information, current financial data, 5300
data (risk management reports and Financial Performance Reports
[FPRs]), and local economic factors;
0 Documented modifications to the preliminary scope based on

examination analysis, unforeseen issues, and emerging problems;
and
Documented sufficient examination procedures used to evaluate

the risk areas using process (e.g., review of policies and
procedures) and transactional procedures to ensure high-risk areas
received in-depth review and low-risk areas only a limited review.
When evaluating resource allocation, the supervisory examiner

considers whether the examiner:
0 Allocated resources appropriate to the risk posed by the credit

union and consistent with the report’s findings and
recommendations;
Page 22-8
Used subject matter examiners (SMEs) to review complex areas

with a significant degree of risk; and
0 Documented material changes to the anticipated examination and

supervision hours.
Proper The examination’s effectiveness depends on the development and

Solutions communication of proper solutions for the risks and problems
identified during the examination. The supervisory examiner will
evaluate the timeliness and effectiveness of the solutions. The
supervisory examiner will determine whether the report:
0 Is clearly written for the credit union officials;

0 Contains reasonable, effective corrective action plans;
0 Assigns responsibility and deadlines for action and defines
benchmarks, as necessary, to attain agreed-upon goals;
0 Provides a realistic plan that will assist officials in resolving the
problems, if followed; and
0 Includes other information such as agreements reached during
discussions with officials and other items as required by regional
management.
The supervisory examiner will evaluate the examiner’s interaction with

management and officials at the joint conference or other exit meeting,
if attended by the supervisory examiner.
Report Form Form includes the clear and professional presentation of facts and
solutions to credit union officials. The supervisory examiner
determines whether the report exhibits the following:
0 Complete, concise, and well-organized discussion and conclusions;

0 Correct grammar, spelling, and punctuation; and
0 Appropriate enhancements such as bolding, underlining, white
space, graphics, and lists for presenting information.
Page 22-9
EXAMINER’S GUIDE
Continuing The supervisory examiner’s evaluation will assess the examiner’s

Supervision/ recommendations for ongoing supervision and future examination
Examination plans. Plans should provide for timely and appropriate supervision to
Plans
ensure prompt resolution of problems and implementation of adequate
measures to control risk. The supervisory examiner will evaluate
continuing supervision and examination plans to ensure they:
0 Focus on material risk-related areas;
0 Monitor the condition of the credit union efficiently and effectively

(may include informal discussions with management and onsite
contacts targeting specific areas of risk);
0 Address future plans regarding any outstanding administrative

action (Discretionary Supervisory Actions, Letters of
Understanding and Agreement, Preliminary Warning Letters,
Cease and Desist Orders, Net Worth Restoration Plans, etc.);
0 Project resources needs for future contacts (hours and examiners

needed, including a specialist or subject matter examiner (SME))
consistent with the report’s findings and recommendations.
Comments The supervisory examiner will use the Comments section of the SE
Evaluation form for items that do not fall under the other criteria, as
explained above.
SE Evaluation Narrative comments clearly document the supervisory examiner’s

Summary evaluation of an examination report. Supervisory examiners will not
rate a report using the terminology “exceeds standards,” “meets
standards,” “minimally meets standards,” or “does not meet
standards.” These terms have specific meanings for the year-end
appraisal process; supervisory examiners should limit the use of these
terms to that purpose only.
If a supervisory examiner notes material deficiencies with an

examination report, the supervisory examiner discusses these with the
examiner, who then signs the evaluation form and returns it to the
Page 22-10
If the supervisory examiner notes no material deficiencies, discussion

of the report occurs at the option of the supervisory examiner or
examiner. The examiner's signature on the evaluation form is optional
at the supervisory examiner's discretion.
The supervisory examiner will submit evaluations to the regional

office in accordance with regional policy.
Page 22-1 1
J J - / & CZi-lJJ
DOS REVIEW AND SE EVALUATION FORMS -
APPENDIX 22A
DOS Review Sample DOS Review Form
I Examiner: I I SE: I I
cu #: I I CUName: I
CAMEL: I Assets:
Effective Date: I I Reviewer: I
Date Completed: I Hours to Complete Exam: I
Date Received: 1 I I
Date Reviewed: I Contact Type:
Risk Category Examiner Risk Category Examiner

Assessment Assessment
Credit I Interest Rate I
Compliance I Strategic I
RISK IDENTIFICATION
SCOPE DEVELOPMENT
PROPER SOLUTIONS
CONTINUING SUPERVISIONEXAMINATIONPLANS
COMMENTS
Page 22A-1
EXAMINER’S GUIDE
SE Evaluation Sample SE Evaluation Form

I CUName: I I Examiner: !
~
CAMEL Comp: Date Report Received:

Days Exam Open: Date Report Appraised:
Effective Date: Budget Hrs:
Hours Charged: Contact Type:
Risk Category Examiner Risk Category Examiner

Assessment Assessment
Credit I I Interest Rate I
Liquidity I Transaction
Compliance I I Strategic
RISK IDENTIFICATION:
SCOPE DEVELOPMENTRESOURCE ALLOCATION:
PROPER SOLUTIONS:
FORM:
CONTINUING SUPERVISION/EXAMINATION PLANS:
~~
COMMENTS:
Supervisory Examiner: Date:
I have reviewed this evaluation and discussed its contents with my Supervisor.
Examiner’s Signature: Date:
(Optional at the SE’s discretion unless the evaluation noted material

deficiencies.)
Examiner’s Comments: (Affix additional pages if necessary)
0
Page 22A-2
STATE CREDIT UNION REPORT REVIEWS =
APPENDIX 22B
State Credit NCUA examiners review state examination reports to determine the
Union Report risk state-chartered credit unions pose to the National Credit Union
Reviews Share Insurance Fund (NCUSIF.) Because economic conditions or
circumstances may vary from one region to another, the regional
directors (at their discretion) may require that examiners expand the
procedures outlined in this appendix and provide additional
documentation.
At a minimum, the NCUA examiner-reviewer (reviewers), after

analyzing the state supervisory authority’s (S SA’s) examination report
and any other pertinent information, assesses the operational and
financial condition of the credit union. In addition, the reviewer
determines if the SSA followed up on problems from the prior
examination, accurately identified problems existing at the current
examination, and reached agreement with the officials to resolve these
problems.
Examiners and regional staff must treat information obtained from the
state examination report reviews as confidential. The region may
distribute the information to the SSA according to the agreements
between the regional director and each SSA.
Ass igning Supervisory examiners normally assign district responsibility,

FlSCUs to including state examination report reviews for federally insured state-
Examiner chartered credit unions (FISCUs), to examiners based on factors such
Districts
as their experience level, technical ability, and areas of expertise. The
supervisory examiner also considers the credit union’s asset size,
complexity, quality of operations, and geographical location.
Supervisory examiners monitor the state examination report reviews to

ensure that reviewers promptly complete high-quality state
examination report reviews that are both accurate in content and
appropriate in their recommendations.
Page 22B-1
EXAMINER’S GUIDE
In order for reviewers to keep abreast of the credit union’s economic

and political environments and the overall quality of the SSA’s
supervision and examination programs, supervisory examiners should
communicate significant changes affecting the state’s examination
program to their district examiners.
While it is the mission of NCUA, as the insurer, to ascertain the safe

and sound operation of FISCUs, examiners must remember that
primary responsibility for the supervision of state-chartered credit
unions rests with the SSA. As in all situations, NCUA examiners
should demonstrate a courteous, professional, business-like, and
cooperative attitude in all communications and contacts with the SSAs
and their staff members.
Processing and The Division of Supervision (DOS) processes state examination

Reviewing state reports, distributes them to field examiners, and monitors the process
Examination for compliance. To ensure compliance with regional and national
Reports
policy, DOS maintains and provides to management staff, at least
monthly, statistics regarding the receipt of state examination reports
and the completion of the report reviews. As a minimum, DOS will
maintain the following statistics:
0 Supervisory examiner, district, insurance certificate number,

NCUA reviewer’s (examiner’s) name;
Date examination report was received from the state;
0 Date examination report was mailed to the field;
0 Date examination report was received in the regional office; and
0 Number of days required for completing the review.
District examiners review state examination reports on a flow basis. To

ensure information contained in the report does not become dated and
that any risk exposure to the NCUSIF is promptly disclosed, examiners
will complete the review within 30 days from the date the regional
office receives the state’s report. If examiners cannot review the report
within the 30-day time period, they should request an extended
Page 22B-2
STATE CREDIT UNION REPORT REVIEWS - APPENDIX 22B
turnaround time from the supervisory examiner and note the reasons
for the extension in the Examiner Comments section of the Examiner
Contact Information. Outstanding state examination report reviews,
however, should not exceed 60 days. Supervisory examiners should
reassign report reviews if they expect extended delays.
Upon receipt of the report, reviewers will:
Review the state examination report, financial performance, and

any other information pertinent to the credit union;
Complete the Examiner Contact Information and upload it to the

host system within three days of completing the review;
Complete a State Examination Report Review Summary and any

other work papers required by the regional director; and
Forward the State Examination Report Review package to the

regional office and supervisory examiner within three days from
the last date the examiner charged time.
Generally, NCUA examiners will not perform a formal review for joint
examination reports (NCUA participates on the contact), or insurance
reviews with an effective date within 30 days before or after the state’s
examination, if the reviewer was also the examiner-in-charge of the
examination. Since the NCUA examiner was recently onsite and
familiar with the credit union, completing a formal review would
duplicate work. However, the examiner will:
0 Scrutinize the state examination report to ensure it contains and

conveys to the credit union the joint findings and recommendations
agreed upon by the NCUA and SSA staff;
0 Complete and upload the Examiner Contact Information;
Note in the Examiner Comments section of the Examiner Contact

Information that this was a joint examination or insurance review
completed 30 days before or after the state examination, and
specifl whether or not the joint report conveyed the joint findings
and recommendations; and
Page 22B-3
EXAMINER’S GUIDE
Forward copies of the Examiner Contact Information to the

regional office and supervisory examiner.
State Examiners will use the review summary (see Attachment 22.1, State
Examination Examination Report Review Summary) to document their analysis of
Review Summary state examination reports during the review process.
The summary contains the narrative detail of (1) the reviewer’s

analysis of the credit union’s financial condition (key trends and
ratios), (2) quality of management, (3) recommendations for future
supervision, and (4)any other related and pertinent information. This
section also contains the reviewer’s conclusions substantiating the
assignment of the CAMEL components and composite ratings.
When reviewing state examination reports, the reviewer should ensure

that the report:
Included all required work papers or equivalent documents;
Adequately addressed major areas of concern noted at the prior

examination and noted implementation of appropriate SSA action;
Provided sufficient information to assess the credit union’s

financial condition;
Adequately disclosed and discussed negative key trends and ratios;
Proposed appropriate solutions to correct the noted major areas of

concern;
Developed supervision plans in line with the conditions found;
Addressed the quality of lending policies and procedures, loan

documentation, and underwriting practices;
Documented that the credit union properly funded the Allowance

for Loan and Lease Losses account (see the Allowance for Loan
and Lease Losses Account chapter of this Guide for additional
information);
Page 22B-4
0 Discussed conformance to Part 723 of NCUA Rules and

Regulations (when business loans exist);
Discussed the adequacy of investment policies, practices, and

controls including compliance with SFAS 115;
0 Documented establishment of an investment valuation reserve for

non-conforming investments in accordance with the share
insurance agreement;
Indicated adequacy of asset-liability management policies,

procedures, and practices based on a review of the financial reports
and information noted in the examination report;
Discussed completion of an acceptable supervisory committee

audit and verification of member accounts that meet the
requirements of Part 715 of the NCUA Rules and Regulations;
Discussed the existence of accurate, reliable, and current

accounting records and operational data;
Completed appropriate questionnaires and addressed deficiencies

noted;
Indicated substantial compliance with the applicable sections of the

NCUA Rules and Regulations; and
0 Documented the accuracy of the 5300 call report data.
The State Examination Report Summary should discuss material

exceptions, including failure to adequately address material exceptions
to one or more of these guidelines.
If the NCUA and state CAMEL composite ratings differ, the reviewer
must present the specific facts, ratios, and justifications to support the
basis for the NCUA examiner's position. The reviewer, while
supporting the NCUA CAMEL rating, should avoid subjective
comments critical of, or antagonistic to, the state examination
program, the state regulator, or the state examiner. Examiners will
consult their supervisory examiners before assigning a composite
Page 22B-5
EXAMINER’S GUIDE
CAMEL rating different from the state’s rating when the variance in
the composite ratings will necessitate an onsite contact. NCUA may
use the support presented by the reviewer to enhance NCUA’s position
to the SSA in those instances where the supervisory examiner finds it
necessary to schedule a joint contact.
Regional Office DOS performs an informal cursory review of all state examination
Review report reviews when the composite ratings of the state and NCUA
differ. DOS also selects a sample of state examination reports to
formally review in accordance with the regional office’s quality control
process.
The regional office review simultaneously assesses the quality of the

SSA’s report and the NCUA examiner’s review of that report. The
DOS reviewer should critique:
0 The analysis of the condition of the credit union;
0 The presentation of pertinent facts, circumstances, problem

identification, and proposed resolution as disclosed in the SSA’s
report; and
0 The NCUA examiner’s review of the report.
The DOS review ensures consistent identification of risk factors that

FISCUs pose to the NCUSIF.
Regional office staff use the comments section at the bottom of the
review summary (see Attachment 22.1, State Examination Report
Review Summary) to document findings, including any deficiencies
noted, of quality assurance reviews performed on the selected sample
of state examination reports. DOS maintains a log of reports that
regional staff reviews and retains for future audits and quality control
reviews.
In addition to the areas that the NCUA examiner reviews, DOS will, at
a minimum, assess the following during its quality control review:
Page 22B-6
0 Timely receipt of SSA’s report - comparison of the effective date,

completion date, and the date the regional office received the
SSA’s report;
0 SSA and NCUA supervision plans - appropriateness and adequacy

of the follow-up plans in the SSA’s report and NCUA examiner’s
review. DOS will note if the credit union’s condition requires, but
the report does not provide supervision plans;
Quality of the NCUA examiner’s review - adequacy of the

narrative, with supporting ratios, to substantiate the ratings
assigned for Capital Adequacy, Asset Quality, Earnings, and
Assefiiability Management, and an overview of Management; and
0 Other comments and observations concerning the SSA’s report,

credit union, or examination process, including (1) identification of
all major areas of concern in the SSA’s report and NCUA
examiner’s review, (2) assessment of the SSA’s solutions to
correct the problems, (3) assessment of the credit union’s
compliance with Section 741 of NCUA Rules and Regulations, and
(4)completion of the required or agreed-upon SSA consumer
compliance questionnaires.
Page 22B-7
State Examination ReDort Review Summary
Ins. #: CU Name:
State: Exam Effective Date:
State Examiner (EIC): Exam Assets:
Date SSA Report Received NCUA Ex.-Reviewer:
from RO:
Date NCUA Review Mailed Exam Contact Type:
I toRO: I
Through the review of the state examination report, the examiner should determine the credit
union’s financial and operational condition and provide sufficient quantitative and qualitative
data to substantiate the analysis and assignment of the CAMEL component and composite
ratings. Current and past trends, effectiveness of problem resolution from prior examinations,
agreements with officials to correct problems, and results of previous supervision contacts
should be addressed in this review. Examiners should base the extent of the narrative on the
risk, size and complexity of the credit union and severity of the problems noted.
.....................................................................................................
COMPOSITE CODE: NCUA CODE STATE CODE
CAPITAL ADEQUACY: NCUA CODE STATE CODE

(Discussion should include past, future, and current aspects of capital.)
ASSET QUALITY: NCUA CODE STATE CODE

(Discussion should include loan programs, quality of lending, appropriateness of
investments, fixed assets, etc.)
MANAGEMENT: NCUA CODE STATE CODE

(Discussion should include supervisory committee audit and verification, policies and
procedures, record keeping, problem resolution, etc.)
EARNINGS: NCUA CODE STATE CODE

(Discussion should include the various components of the income statement (e.g.,
gross income, operating expenses, and the cost of funds.)
LIQUIDITY MANAGEMENT: NCUA CODE STATE CODE

(Discussion should address the adequacy of liquidity and appropriateness of the
ALM policy.)
Attachment 22.1
22.6-9
EXAMINER’S GUIDE
INSURABILITY REQUIREMENTS: (Does the report provide adequate

information to assess compliance with part 741 of the NCUA Rules and Regulations,
including the Requirement for Insurance, and with applicable federal consumer
regulations?)
APPROPRIATENESS OF SSA PROBLEM RESOLUTIONS AND FOLLOW-

UP PLANS: (Does the report provide documents of resolution and examiner’s
findings and are they appropriate and adequate? List any supervision plans the SSA
has provided in the report. (Please indicate if none are provided.))
NCUA EXAMINER RECOMMENDATIONS: (Are offsite supervision and

monitoring plans or formal onsite supervision plans appropriate given the condition
of the FISCU?)
OTHER ITEMS:
The information contained on this form is based on our review of the state examination report.
Attachment 22.1
Chapter 23
LOW-INCOME CREDIT UNIONS
TABLE OF CONTENTS
LOW-INCOME CREDIT UNIONS ................................................................................ 23-1

Examination Objectives ..................................................................................... ..23.1
Risk Categories .................................................................................................... 23-1
Overview.............................................................................................................. 23-1
Qualifying for the Low-Income Designation ..................................................... ..23.3
Field of Membership and Chartering ....................................................... 23-4
Nonmember Deposits.......................................................................................... .23.5
Booking Nonmember Deposits .............................................................. ..23.5
Use of Nonmember Deposits ................................................................... 23-5
Waiver ofthe 20 Percent or $1,500,000 Rule ...................................................... 23-6
Community Development Revolving Loan Fund ................................................ 23-6
Technical Assistance Program ............................................................................. 23-8
Mentoring............................................................................................................ .23.9
Secondary Capital ................................................................................................ 23-10
Examiner’s Responslblllty. . . ................................................................................... . 23.1 1
Recordkeeping .................................................................................................... . 3.21 1
Delinquency and Charge.Offs ............................................................................. . 23.1 2
Expense Ratios .................................................................................................... .23.12
Business Lending ................................................................................................. 23-13
. . Received ......................................................................................
Contnbutions ..23.13
Asset-Liability Management............................................................................... . 23.1 4
Board and Management ...................................................................................... . 23.1 4
References............................................................................................................ 23-15
Chapter 23

Examination Determine that any nonmember deposits comply with
Objectives limitation, use, and recording requirements
0 Determine that any waivers received proper approval
0 Determine that Community Development Revolving Loan
Fund for Credit Unions’ funds meet the requirements of that
program
Evaluate management’s ability to identify, measure, monitor,
and control (i.e., manage) risk
Determine the credit union’s current and potential risk
Evaluate the adequacy and accuracy of management’s risk
reporting mechanisms
Assess the credit union’s ability to withstand any negative
effects of risks taken in relation to its financial condition and
net worth position
Work with management to reach agreeable solutions to reduce
levels of unwarranted risk
Risk Low-income credit unions, like all credit unions, are subject to the
Categories seven categories of risk, discussed in the Risk-Focused Program
chapter. These risks include Credit, Interest Rate, Liquidity,
Transaction, Compliance, Strategic, and Reputation. As with other
credit unions, low-income credit unions must mitigate their risks by
implementing measures such as management’s due diligence, sound
internal controls, the audit process, and well-trained management and
staff. These should coincide with the size and complexity of the credit
union.
Overview Low-income credit unions have the same mission as other credit
unions, with an additional requirement: a majority of their members
must meet or fall below the income standard set by the NCUA Rules
and Regulations. For many low-income members, their credit union
serves as the only access to financial services.
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EXAMINER'S GUIDE
The task of operating a low-income credit union challenges its officials

and management for a number of reasons, including:
0 The membership tends to include more renters, who may move

more often than homeowners;
Members often need high cost, labor-intensive services such as

money orders, financial counseling, and check cashing;
0 Members tend to have limited financial reserves and have fewer

resources to overcome the effect of setbacks such as illness, an
expensive car repair, or a job cutback; and
0 Member share account balances tend to be low for these credit

unions. To provide needed services, low-income credit unions may
have to augment savings with nonmember deposits. Low-income
credit unions often have cooperative relationships with a variety of
social services and other organizations.
The FCU Act uses the term "low-income" credit union to refer to credit
unions having "predominantly" low-income members. $701.34(a)(2) of
the NCUA Rules and Regulations defines low-income members to
mean those members (1) who make less than 80 percent of the average
for all wage earners as established by the Bureau of Labor Statistics;
(2) whose annual household income falls at or below 80 percent of the
national median household income as established by the Census
Bureau; or (3) who otherwise qualify as low-income by order of the
NCUA Board. The NCUA Office of Credit Union Development
(OCUD) annually publishes the qualifling thresholds for the national
average wage and median household income. In applying standards,
the NCUA regional director shall make allowances for geographical
areas with higher costs of living.
The term "low-income" also includes student credit unions. Student

credit unions may accept nonmember deposits, but cannot participate
in the Community Development Revolving Loan Program discussed
later in the chapter.
Credit unions that NCUA designates as "low-income" can (1) receive

nonmember deposits from any source in addition to deposits from
Page 23-2
public units and other credit unions, ( 2 ) offer secondary capital

accounts and include this account in the credit union's net worth, (3)
qualify for an exception from the aggregate member business loan
limit, and (4) participate in the Community Development Revolving
Loan Fund for Credit Unions.
Qualifying for Examiners should understand that a credit union may meet the income
the Low- standard that makes it eligible for the low-income designation, but has
Income not yet applied for or received the designation. Lower-than-average
Designation account balances, loan balances, and member incomes (as documented
in the loan files) may indicate an institution qualifies as a low-income
credit union. $701.34 of the NCUA Rules and Regulations outlines the
low-income designation requirements. Examiners should encourage
any credit union that may qualify to request the low-income
designation.
Examiners should also discuss the opportunity to expand credit union

services to underserved communities in certain credit unions identified
for such possible expansion by the region, the supervisory examiner, or
the examiners themselves. When meeting with credit union officials,
either at the joint conference or exit interview, examiners must clearly
state that the discussion regarding increasing credit union service to
underserved communities is not part of the examination. Examiners
should briefly document whether they held such a discussion and the
credit union's response in the Confidential Section of the examination
report.
Credit unions requesting the low-income designation should support

their requests with sufficient documentation to demonstrate that they
serve predominately low-income members by providing the following:
Individual documentation of the members' individual incomes;

0 Individual documentation of the members' household incomes;
0 Membership surveys; andor
0 Income levels of members identified by zip codes or census
block data, or demographic information customarily used and
accepted to document low-income eligibility for federal and
state programs.
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EXAMINER’S GUIDE
Any credit union, not just one with a community charter, can use these
methods for qualifying. For example, a church-based associational
credit union could meet the standard if most of its members live in a
cluster of zip codes or census blocks, which if averaged together, meet
the income standard.
Credit unions can obtain this income information from U.S. Census
publications in public libraries and on the Internet at the Census
Bureau’s website (http://www.census.gov/). Examiners can obtain
demographic information on behalf of the credit union from their
NCUA regional offices. If the demographics fail to show that the credit
union’s operational area has a median household income within
regulatory limits, the credit union can document the wages of its
members.
State-chartered credit unions should first approach their state

supervisory authority (SSA) to obtain the designation, which is subject
to NCUA regional concurrence. If the state has no such designation,
then the credit union should apply to NCUA. NCUA’s procedures for
state-chartered credit unions will mirror those for federal credit unions.
In the event that state law does not provide for a low-income
designation, the regional director would approve the designation after
obtaining concurrence of the SSA. The possibility exists that state laws
would prohibit certain activities, such as acceptance of nonmember
accounts.
The examiner should notify the supervisory examiner of any low-

income designation problems before discussing them with the officials.
If examiners review problems associated with the low-income
designation, they should disclose the results of that review in
accordance with regional policy.
Field of A prospective credit union may submit a separate low-income

Membership and designation request with its charter application. The potential field of
Chartering membership forms the base for a charter applicant’s low-income
designation. If the prospective credit union provides the appropriate
documentation, NCUA may grant the low-income designation and
charter simultaneously.
Page 23-4
Nonmember Low-income designated credit unions can accept nonmember accounts.

Deposits They can use these nonmember accounts to (1) fund loans, (2)
arbitrage and build reserves, or (3) cover expansion or services costs.
Generally, these deposits have interest rates at or below market rates.
Nonmember accounts in a low-income designated credit union mean

shares, share certificates, share drafts, or other types of nonmember
deposit accounts approved by the NCUA Board. Unless the regional
director has approved a greater amount, the maximum amount of all
public unit and nonmember shares cannot, at any given time, exceed
the greater of 20 percent of the credit union's total shares or $1.5
million. During each examination, the examiner should review
compliance with the nonmember deposit limit. (Credit unions eligible
for Part 742, the Regulatory Flexibility Program, may be exempt from
some of the nonmember share limitations.)
The examiner may assist the credit union in understanding the need
and proper use for nonmember deposits. The credit union should
negotiate a mutually acceptable time span for the deposit, with
adequate notice before withdrawal. It must guard against interest rate
risk resulting from an interest rate agreement that could force it into a
negative spread position if market rates change. Deposits that create a
negative spread, whether brokered or otherwise, are unsuitable for any
credit union, including low-income credit unions.
Booking Where permitted, low-income credit unions record accounts of

Nonmember nonmembers as "nonmember deposits," not as notes payable, and
Deposits report them in the equity section of the balance sheet. Some states do
not permit nonmember accounts. In these states, the credit union
records the f h d s as notes payable. NCUSIF insurance does not cover
notes payable.
Use of Credit unions may invest nonmember deposits using the safety,
Nonmember liquidity, and yield (SLY) principle, or they may loan out nonmember
Deposits deposits. To mitigate interest rate and liquidity risks, management
should have a plan that coordinates the maturity of the loan or
investment with the maturity of the deposit.
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EXAMINER'S GUIDE
Waiver of the A low-income credit union must apply to the regional director for a
20 Percent or waiver of the 20 percent of total shares or $1.5 million threshold.
$1,500,000 Federally insured state-chartered credit unions must also obtain the
Rule concurrence of the appropriate state regulator. (Credit unions eligible
for Part 742, the Regulatory Flexibility Program, may be exempt fiom
some of the nonmember share limitations.)
The application for a waiver serves as a check to determine that the

nonmember funds do not pose an undue risk to the NCUSIF. All
requests for a waiver must include a plan outlining the need and
proposed use of the deposits. 5701.32 of the NCUA Rules and
Regulations contains specific requirements governing the waiver
process.
When determining the nonmember deposit ratio, $701.32 permits

exclusion of (1) matching funds required under the Community
Development Revolving Loan Program for Credit Unions, (2) Treasury
Tax and Loan Depositaries accounts, and (3) Depositaries and
Financial Agents of the Government. This chapter discusses funds
specified in (1) above in more detail.
There is a presumption in favor of granting the credit union's request

when the credit union has mitigated its risk through sound financial
condition, good management, and a reasonable plan for the funds. The
regional office will provide a written determination within 30 calendar
days of receipt of the request. The credit union has the right of appeal
in the case of denial.
Community NCUA administers the Community Development Revolving Loan

Development Fund (Fund) for Credit Unions. The Fund consists of two programs:
Revolving (1) a loaddeposit program, and (2) a technical assistance program. Part
Loan Fund 705 of the NCUA Rules and Regulations contains detailed information
about the governance and operation of the Fund.
The purpose of the Fund supports the efforts of participating credit

unions through loans to them for (1) providing basic financial and
related services to residents in their communities, and (2) stimulating
economic activities in the communities they service, which will result
in increased income, ownership, and employment opportunities for
Page 23-6
low-income residents, and other community growth efforts. (As noted

earlier, student low-income credit unions may not participate in the
Fund.)
Credit unions can apply for Fund loans any time during the year. Loans
repay in five years; however, NCUA will consider shorter repayment
periods. Generally, credit unions repay the loans in semiannual
installments, with no principal balance repayment due until the second
semiannual installment. The last installment will require a double
principal payment.
The aggregate loan limit to one credit union is $300,000. No credit

union may have more than two separate loans at any one time. There is
no minimum loan amount. While the OCUD can tailor the terms and
conditions of the loans to an individual credit union’s circumstances,
all loans carry a fixed interest rate, which the NCUA Board sets
annually. Credit unions may record a Fund loan or deposit as either a
note payable or as a nonmember deposit, at NCUA’s discretion.
The Fund’s loan agreement requires the credit union to develop other
sources of matching funds as described in §705.7(b). Credit unions can
match loan funds “dollar-for-dollar” with nonmember deposits.
However, they can match loan funds with member deposits as a “two-
for-one” match. Within one year of receiving the Fund loan, the credit
union must match the loans with member shares or nonmember
deposits. Nonmember deposits accepted to meet the matching
requirement are not subject to the 20 percent limitation on nonmember
deposits under $701.32.
The examiner should understand that credit unions need not reduce the
matching deposits as they pay down the loan. As a result, the matching
funds may exceed the loan balance once principal repayments begin. A
credit union may continue to exclude the full amount of matching
funds consisting of nonmember deposits from the nonmember deposit
rule calculation as long as the credit union has any loan balance on its
books.
In addition, the examiner should understand that the presence of the

Fund’s loan plus matching deposits could significantly affect financial
Page 23-7
EXAMINER’S GUIDE
ratios of small asset size credit unions, lowering every ratio having
assets, average assets, or shares as the denominator.
The income earned by the Fund’s loan program supports the Fund’s
technical assistance program. Examiners should know about the Fund
and encourage its use, when appropriate.
Credit unions can request Fund loan applications from either OCUD or
the applicable regional office. The Director of the OCUD serves as the
Community Development Revolving Loan Fund Chairman, and
assumes administrative responsibilities. The Fund’s chairman may
restrict the use of funds, approve less than the full amount requested,
or deny the loan. The chairman may require a credit union to invest the
funds in a specified way and take the positive spread as income. No
special restrictions apply to the use of matching funds except the usual
safety and soundness considerations, unless specifically noted in the
loan agreement.
Technical The income earned on the Fund’s assets and possibly congressional
Ass ista nce appropriations provide monies for technical assistance grants to credit
Program unions. NCUA makes these grants to aid participating credit unions in
providing services to their members and in the efficient operation of
the credit unions. Only a credit union with a NCUA low-income
designation may participate in the Technical Assistance Program (i.e.,
low-income student credit unions can not participate in this program.)
Credit unions submit technical assistance applications to OCUD. The

agency has a goal of using technical assistance grants for credit unions
where this funding could make the greatest impact on improving their
operations. Since NCUA has limited technical assistance funds
available, smaller grants enable a larger number of credit unions to
participate. No specific limitation on the amount of the grant request
exists; however, the average technical assistance grant approved is
under $5,000.
Credit unions may apply for technical assistance grants anytime during
the year. They must obtain approval of the technical assistance grant
before committing to, or contractinp for, the service or purchase. Once
OCUD approves the request for technical assistance, the credit union
Page 23-8
must submit an original invoice showing proof of service or purchase

for payment.
NCUA Rules and Regulations $705.10 describes the technical

assistance program and provides guidance for completing the technical
assistance application.
Mentoring When appropriate, examiners should encourage credit union

management to network and seek assistance from trade groups,
associations, credit unions, and banks. Mentoring can help small credit
unions mitigate several risk factors and provide them the assistance
they need with little or no direct dollar expense.
Mentoring can take many forms including:
Nonmember accounts. Credit unions can use nonmember accounts

to fund lending, build shares, arbitrage and build reserves, or cover
costs of expanding services.
Training. Inexperience in credit union operations is the leading

reason many small credit unions fail. Due to limited financial
resources, volunteers in small credit unions often do not have an
opportunity for training.
Marketing advice. Small credit unions that have limited access to

network with other credit unions may have difficulty developing
plans for increasing membership. A mentor’s marketing tips could
help extend the credit union’s outreach programs.
Supervisory committee training. The annual audit is a major

expense for small credit unions. Small credit unions usually have
basic share and loan operations. A mentor could actually perform
the supervisory committee audit or assist the supervisory
committee in performing the audit.
Credit committee training. Low-income credit unions often serve

members for whom proper credit evaluation is essential.
Understanding the need for proper documentation on collateral or
the ability to identify appropriate collateral could enable the credit
Page 23-9
EXAMINER'S GUIDE
union to reduce delinquency and write-offs. A minimal

commitment by a larger credit union to allow their loan specialist
to train employees of the low-income credit union could help
mitigate credit risk and improve operations.
Fee-based back-office services. Many small credit unions do not

have the personnel available or the expertise to fill all operational
functions. A mentor could provide these services on a fee-based or
no-cost arrangement.
0 Loan participation. Properly managed, loan participation could

benefit both participants. Larger credit unions can help low-income
credit unions provide liquidity for loans needed by the low-income
credit union's membership. Low-income credit unions can benefit
from the lending expertise and policies of the larger credit union.
Examiners should review the loan participation agreement.
Secondary A federal credit union with a low-income designation may offer

Capital secondary capital accounts to non-natural person members and non-
natural person nonmembers. Uninsured secondary capital accounts are
part of the low-income designated credit union's net worth. Examiners
should refer to $701.34(b) for information regarding secondary capital
accounts conditions and requirements.
The NCUA Board established key safety and soundness element, to

ensure (1) the availability of secondary capital accounts to absorb
losses, and (2) the investor understands the risks involved. In $701.34,
the NCUA Board permits credit unions to offer secondary capital
accounts providing the credit union does the following:
Offers the accounts to organizational investors only, not to natural

persons;
Subordinates the accounts to all other claims on the assets of the

credit union, including claims of creditors, shareholders, and the
NCUSIF;
0 Does not offer the accounts as share accounts and discloses they
are not insured by the NCUSIF, or any other government entity;
Page 23-10
Makes the funds available to cover losses after depletion of

reserves and undivided earnings, but before liquidation;
Establishes the accounts with a minimum maturity of five years,

which may not be redeemable before maturity;
0 Requires that the investors sign standard account agreements and

disclosures (per the Appendix to $701.34) and retain them for at
least the life of the loan;
Recognizes the capital value of an account having a remaining

maturity of less than five years on a declining scale for each
subsequent year (i.e., accounts with maturities between four and
five years will have capital value of 80 percent of the balance,
those with three to four years remaining - 60 percent, two to three
years remaining - 40 percent, one to two years remaining - 20
percent, and accounts with maturities of less than one year - zero
capital value). All of the funds, however, will remain at risk; and
Adopts and submits to the regional director a written plan that

addresses the use of the funds and provision for liquidity upon
maturity. The credit union need not wait for approval.
Finally, under prompt corrective action (PCA), NCUA can restrict

payment of principal or interest on uninsured secondary capital of a
low-income designated credit union classified as critically
undercapitalized.
Examiner’s To determine the existence of compliance risk, examiners should

Respon- review outstanding Fund loan agreements for compliance during each
sibility examination. If the credit union has a compliance problem, the
examiner should seek direction from the supervisory examiner about
the approach to use in discussing it with the officials. As a minimum,
the examiner should disclose the results of the Fund’s loan review in
the Confidential Section of the examination report.
Record The examiner should ensure that the credit union understands
Keeping transaction risk and the importance of keeping accurate and complete
Page 23-11
EXAMINER'S GUIDE
records. If necessary, the examiner should help the credit union obtain
the assistance and training it needs to gain competence in record
keeping.
Delinquency The credit union needs a functioning, written, effective loan collection
and Charge- program. Improving the loan collection program would benefit many
offs low-income credit unions. Examiners should encourage low-income
credit unions to react quickly (within a few days after a missed first
payment) to each delinquency. Many low-income credit union
members have a difficult time recovering if they get behind in their
payments. The loan collection program may benefit from expanding
the role of credit counselor to include community resources referral.
When classifying loans, managers often have personal knowledge of

individual members who, despite high debt ratios or slow repayment
records, are of good character and likely to repay. Examiners should
consider management's judgment when discussing which loans the
credit union should charge off.
Expense As a result of some characteristics of low-income credit unions

Ratios (discussed in the Overview section of this chapter), these credit unions
sometimes have higher expense ratios than other credit unions. In
addition, delinquency (e.g., collection costs, loss of income, provision
for loan loss expense) and net charge-offs may have more periodic
volatility.
Compared to other credit unions, low-income credit unions generally

have slightly higher employee compensation and benefits expense
ratios. Low-income credit unions tend to have a slightly larger full-
time staff than do occupational groups that receive payroll deductions,
and tend to pay slightly more per employee. Office operations and
occupancy expense ratios are also higher on average.
Examiners should counsel management and the board on expense

control. Although NCUA recognizes that low-income credit unions
operate with higher expenses, this counseling can help management
with the budget process, cost-benefit analysis, and maximize earnings
potential.
Page 23-12
Business Low-income credit unions historically have regarded lending to small

Lending businesses as a major part of their mission. The examiner should
obtain a historical perspective on the credit union’s previous success
with this kind of lending before commenting to the credit union about
its program.
For low-income credit unions that have not previously engaged in

business lending, examiners should help ensure the credit union
obtains needed expertise to succeed in this program, either through
training or hiring. The examiner should remind the credit union that it
must meet the requirements of the business lending regulations in $723
of the NCUA Rules and Regulations. In addition, the examiner may:
0 Encourage the low-income credit union to obtain training through

technical assistance;
Suggest help from other credit unions; or
0 Assist the manager in identifying the qualities and expertise needed
in prospective employees.
Low-income designated credit unions may also participate in various

mortgage and business loan funding sources sponsored by government
or private programs. The examiner should review outstanding
contracts governing the use of the funds and reporting requirements to
determine if the credit union’s activities with regard to such programs
present significant risk. Examiners must ask sufficient questions to (1)
understand the funding arrangement (some are complicated), (2)
determine the legality of the arrangement, and (3) determine that the
arrangement serves the credit union’s best interest from a safety and
soundness standpoint. If examiners have concerns about a funding
arrangement, they should discuss those concerns with their supervisory
examiners before discussing them with the officials.
Contributions Sponsors or other parties occasionally provide the credit union a gift or
Received donation such as cash or a fixed asset. Low-income credit unions are
more likely than other credit unions to receive such assistance. Credit
unions under $10 million may accept fixed asset gifts and record them
as donated equity. Credit unions with assets of $10 million or more
must follow GAAP and record unconditional gifts as income when
received. All credit unions must record gifts of cash as income. The
Page 23-13
EXAMINER'S GUIDE
examiner must ensure that the credit union properly records such gifts
on its books. Credit unions should use the gifts for the purpose for
which they were donated.
Asset- While sufficient liquidity is the objective of asset-liability management

Liability (ALM), proper matching of sources and uses of funds has particular
Management importance in low-income credit unions with their nonmember
deposits, the Fund's loan, and matching deposits. To maintain an
adequate match, credit unions should invest nonmember deposits and
loan funds in instruments that have maturities compatible with the
term of the loan or deposit.
Board and Well-trained officials and paid staff remain as crucial to low-income
Management credit unions as to any other credit union. A well-diversified board,
which includes community leaders, brings a variety of talents to work
for the credit union and encourages the sharing of collective
knowledge among all officials. Every credit union management team
should develop a plan addressing four basic elements of operation:
0 Get Money In,

Get Money Out,
0 Get Money Back with Interest, and
0 MakeaProfit.
Often, in smaller credit unions, the lack of sufficient internal controls,

including inadequate segregation of duties and insufficient backup
support for the manager and key staff, can present a serious concern
when knowledge about the credit unionls operation is concentrated in
one or a few staff members. Frequently, the officials and volunteers
assume verification and backup responsibilities by taking on some of
the more labor-intensive services (e.g., collection efforts and bank
reconcilements.) The officials must address the need for management
continuity and succession planning.
The officials can often increase the credit union's viability by seeking
out ways to increase their participation in the credit union. This may
include encouraging board members to participate in loans and
Page 23-14
savings, or it may mean increasing membership by penetrating

potential fields of membership.
$715.4 and $715.8 of the NCUA Rules and Regulations and $ 115 of
the FCU Act require the officials to obtain an annual audit and
verification of the members’ accounts at least once every two years.
$715.5 requires an outside, independent CPA audit under certain
conditions. If the credit union receives $300,000 or more in
government funds (including the Fund’s loan, other public monies or
federal government appropriation funds), it must obtain an
independent audit as required by the Single Audit Act Amendment of
1996, $7501(a)(14) and §7501(b)(3) of Title 31. The examiner must
monitor the credit union’s use of federal awards and assess the quality
of their audits.
The examiner should recognize the importance of meeting directly

with the officials. As in any credit union, the examiner should:
Recognize the credit union’s progress;

Discuss with the officials areas in need of strengthening and ensure
that the officials and necessary staff understand the concerns;
Develop and prioritize action plans with the credit union’s help;
and
Ensure that the credit union has resources to implement action
plans. Technical assistance may aid the credit union in these
efforts.

- Part115
- $701.32
- $701.34
- $715.4
- $715.5
- 5715.8
- Part705
- Part723
NCUA Chartering and Field of Membership Manual
Accounting Manual for Federal Credit Unions
Page 23-15
Chapter 24
SHAREDBRANCH
TABLE OF CONTENTS
SHARED BRANCH ....................................................................................................... . 24. 1

Examination Objectives...................................................................................... . 24. 1
Overview............................................................................................................. . 24. 1
Officials of Participating Credit Unions .............................................................. 24-2
Examination Procedures ..................................................................................... .24.2
References ........................................................................................................... .24.3
APPENDIX 24A .Shared Branch CUSO ...................................................................... 24A-1
APPENDIX 24B .Shared Branch CUSO Review Procedures........................................ 24B-1
d3./7. 023 d
&
Chapter 24
SHARED BRANCH
Examination 0 Determine whether the shared branch functions as a separate entity
Objectives 0 Assess whether the design of the shared branch agreement provides
stability and limits the risk to the participating credit unions
0 Determine whether the services offered by the shared branch
operation comply with NCUA Rules and Regulations
0 Determine whether the shared branch operation poses significant
risk to the participating credit union’s financial condition
Associated Strategic risk - Includes the risk that a poorly managed CUSO
Risks will adversely affect the credit union’s strategic goals and
plans.
Transaction risk - Includes the risk that member transactions
will not be posted properly or promptly.
Compliance risk - Includes the risk that CUSO personnel will
not comply with applicable laws and regulations.
Reputation risk - Includes the risk that the quality of service
received at the CUSO will affect the credit union’s reputation.
Overview A shared branch operation, also known as a shared service center, can
be structured as a corporation, limited liability company, or limited
partnership, or it can result from an agreement with a third-party
vendor that provides branch office services to more than one credit
union. Many shared branch operations exist as Credit Union Service
Organizations (CUSOs). Others may function as correspondent credit
union activities or service contract activities.
Shared branch arrangements can provide added benefits to credit union

members. For example, additional branch locations and services, and
expanded office hours increase convenience to the membership.
Additional services may include traveler’s checks and money orders,
utility bill payments, notary services, etc. The credit union may
potentially reduce transaction costs because of economies of scale.
Page 24-1
EXAMINER'S GUIDE
Thus, participating credit unions can offer these benefits without

acquiring additional fixed assets or adding staff.
A shared branch operation is chartered under state law, and is not

directly regulated by NCUA. However, since shared branch networks
primarily perform member transactions, and the majority of the
network's assets consist of credit union funds, NCUA has the
responsibility to limit the exposure to the National Credit Union Share
Insurance Fund (NCUSIF).
Officials of The board of directors of participating credit unions must perform due
Participating diligence regarding the shared branch operation. This includes
Credit Unions reviewing the shared branch management and financial reports (such
as board minutes, financial statements, budgets, audit reports, etc.) and
periodically performing a costhenefit analysis of the shared branch
operation.
The participating credit unions must closely monitor the activities of

the shared branch operation to mitigate the risks, both to the shared
branch operation and to the participating credit unions as a result of the
shared branch operation.
Examination The examiner should determine if the credit union participates in a

Procedures shared branch arrangement. If the shared branch is a CUSO, the
examiner should determine whether the operation complies with Part
7 12 of the NCUA Rules and Regulations. (See Appendix 24A for
further discussion of CUSO shared branches, Appendix 24B for shared
branch CUSO review procedures, and the Credit Union Service
Organizations (CUSO) chapter of the Guide for information on CUSO
reviews.)
The examiner should ensure the credit union has a signed agreement
with the shared branch provider. Examiners should document the
review of the shared branch in the Scope Workbook. The examiner
may include in the examination report, or possibly in the
Supplementary Facts section, a discussion of the shared branch
network.
Page 24-2
SHARED BRANCH
Examiners should inform their supervisory examiners when they learn

about newly formed or previously undetected shared branch networks.
Part 712, Credit
Union Service Organizations (CUSOs)
Page 24-3
SHARED BRANCH CUSO = APPENDIX 24A
Review a Determine whether the degree of risk the CUSO poses to affiliated
Objectives credit unions and the NCUSIF is acceptable
a Review the financial stability and soundness of operations
a Determine the experience level, capabilities, and effectiveness of
management directing the shared branch CUSO
a Determine the adequacy of policies, procedures, and controls
safeguarding the assets of the participating credit unions and the
individual credit union’s membership
a Determine whether the CUSO maintains accurate and current
records
a Determine the adequacy of surety bond coverage
a Ascertain whether contracts are legal and binding and do not
require conditions or costs which adversely affect the financial
condition or operations of the participating credit union
a Determine whether the shared branch CUSO operates in
compliance with applicable laws and Part 7 12 of NCUA Rules and
Regulations
a Determine the stability of the shared branch CUSO’s participants
Associated Strategic risk - Includes the risk that a poorly managed shared
Risks branch CUSO will adversely affect the credit union’s strategic
goals and plans.
Transaction risk - Includes the risk that member transactions will
not be posted accurately or promptly.
Compliance risk - Includes the risk that shared branch CUSO
personnel and management will not comply with applicable laws
and regulations.
Reputation risk - Includes the risk that the quality of service
received at the shared branch CUSO will harm the credit union’s
reputation.
The participating credit unions must ensure they closely monitor the
activities of the shared branch CUSO operation to mitigate these risks.
Page 24A-1
EXAMINER'S GUIDE
Overview NCUA and the respective states periodically review shared branch
CUSO operations. When only federally chartered credit unions
participate in the CUSO, NCUA will perform the review. If federally
insured state-chartered credit unions constitute the participating credit
unions, the state assumes primary responsibility for the review, but
NCUA may participate as the insurer. If all of the credit unions are
privately insured, NCUA does not participate in the review. However,
if a combination of federally insured and privately insured credit
unions exists, NCUA requires access to the shared branch facility and
all necessary records. §712.3(d)(3) of NCUA Rules and Regulations
stipulates the CUSO will provide NCUA complete access to any books
and records of the CUSO and the ability to review CUSO internal
controls. Examiners should keep in mind NCUA does not regulate
CUSOs, only the credit union's investment in or loan to the CUSO.
(Examiners should review both the Credit Union Service

Organizations (CUSO) and the Shared Branch chapter for additional
information.)
Review of a Since shared branch CUSOs potentially involve a large number of

Shared credit unions, the regional director and the state supervisory authority
Branch CUSO should coordinate and give approval before the examiner schedules the
review. Examiners should review regional guidance to determine the
correct procedures for requesting a CUSO review.
Shared-Branch Review procedures may vary depending on the size and structure of
Review the shared branch arrangement. Examiners should consider reviewing
Procedures the following areas:
0 Structure of organization. To understand and evaluate the shared

branch operation, the examiner should:
- Identify the size, structure, and services during initial meetings

with the CUSO's management;
- Obtain and review a list of all participating credit unions, and
the corresponding contracts and arrangements;
- Obtain an organizational chart of the CUSO; and
Page 24A-2
SHARED BRANCH CUSO - APPENDIX 24A
- Determine the legal aspects of the CUSO by reviewing the

Articles of Incorporation, Bylaws, contracts, and any legal
opinions.
Capital structure and financial condition. Several methods exist for

fimding a shared branch CUSO by the participating credit unions.
The examiner should determine the following during the review of
the shared branch operation’s capital structure and financial
condition:
- The sufficiency of the CUSO’s funding. Weak or inadequate

funding arrangements may require additional, unanticipated
costs to the participating credit unions;
- The reasonableness of projected operating and capital costs

under a variety of hture operating and economic environments;
- The future plans of management for the shared-branch CUSO.

By reviewing management’sbudgetary process, business plan,
and projected cash flows, examiners can estimate the effect
such plans will have on the cost to participating credit unions;
- The stability of the CUSO’s financial condition. By analyzing

ratios and financial trends in comparison to current industry
standards, the examiner can evaluate the organization’s
financial performance. Examiners may need to review several
years of ratios and financial trends, if available. Ideally,
participating credit unions should track their own per-
transaction costs and compare those costs to the monthly fees
of the shared-branch CUSO arrangement; and
- The changes in costs incurred by and transaction fees charged

to the member credit unions over time. These include
reviewing and analyzing income and expense, transaction costs,
and monthly fees charged to the participating credit unions for
appropriateness and proper controls. In most cases, economies
of scale should reduce transaction costs in a growing shared
branch CUSO.
Page 24A-3
EXAMINER'S GUIDE
Management. The examiner may determine the quality and

capabilities of management. The review of shared branch CUSO
management is similar to the review of management performed
during a regular credit union examination. The examiner should
review:
- Minutes of board and appropriate committee meetings;

- The CUSO's mission statement and business plan;
- Policies and procedures;
- Personnel hiring practices including qualifications, training
programs, and evaluation procedures;
- Management contracts;
- The planning and budgetary process; and
- Methods by which participating credit unions have input in the
operation (i.e., users' meetings.)
0 Recordkeeping. The examiner should determine the records

accurately reflect the financial condition of the shared branch
CUSO, management accurately evaluates the costs of each separate
shared branch, and the shared branch operation has reasonable and
accurate records for allocating the costs and fees to the
participating credit unions. The examiner should consider
reviewing and testing the following items to determine the
accuracy of the records:
- Material general ledger and sub ledger accounts;

- A sample of bank statements and reconcilements;
- Major income and expense accounts;
- Internal audit practices, procedures, and workpapers; and
- Branch accounting procedures for allocating operating costs
and assessing monthly fees and charges to the participating
credit unions.
0 Annual audit. The examiner should determine that the shared

branch CUSO obtains annual audits. Examiners may review the
most recent audit report and workpapers, including the
confirmations of the member credit unions' investments, deposits,
and additional paid-in-capital.
Page 24A-4
0 Lending practices. The examiner should determine the type and

extent of lending practices at the shared branch CUSO. Lending
practices vary from one branch to another. Some shared branches
only receive and forward applications to the participating credit
unions for approval. Others receive loan applications, forward
them to the participating credit union, and disburse the loan funds.
In federal credit unions, an automated loan system, programmed to
implement loan policies can approve loan applications. The
automated loan system cannot deny applications; they can only
refer the applications to a loan officer for lending decisions that the
system's preset lending criteria would deny.
The depth of review depends on the extent of the lending practices.

When the shared branch receives applications and disburses loan
proceeds, but the participating credit union approves the loan, the
examiner can limit the review to the controls for membership
determination, document verifications, and disbursement
procedures. In a shared branch CUSO for federal credit unions,
shared branch staff cannot approve applications unless a loan
officer is onsite. The examiner should determine that the practices
and procedures used by the shared branch comply with the member
credit union's individual loan policies.
Internal controls. The examiner should review and evaluate all

operating policies and procedures and determine that the shared
branch has implemented complete and adequate internal controls
throughout the shared branch CUSO operation. Examiners should
make suficient onsite contacts to shared branch offices to verify
the standardization and consistency of the practices. When
performing onsite contacts at the branches, examiners should
consider reviewing the following:
- Control of cash, money orders, traveler's checks;

- ATM and night depository procedures and controls;
- Access and control of passwords, keys, etc.;
- Controls for preventing staff from performing fraudulent
transactions on their own or family members' accounts at the
participating credit unions;
- Procedures for verifying membership and for becoming a
member at the shared branch office;
Page 24A-5
EXAMINER’S GUIDE
- Procedures for safeguarding information about the member,

and;
- Contingency plans including backup systems, procedures, and
authorization for member transactions when the computer is off
line.
0 Insurance and surety bond coverage. The examiner should

determine that the shared branch CUSO has sufficient insurance
and surety bond coverage to protect the assets of the operation and
limit potential loss to the participating credit unions. Examiners
should review the adequacy of the bond coverage, whether on a
standard bond form as seen at many credit unions or on other
forms. (No regulatory requirement for minimum bond coverage
currently exists for a shared branch CUSO.)
Information processing. Complex information processing

procedures may exist at a shared branch CUSO. Processing
transactions at various credit unions from one teller station requires
that the shared branch employ a system commonly known as a
“switch” which selects and accesses the appropriate credit union.
To safeguard members’ assets, the policies, procedures, and
internal controls must control and limit access to authorized
transactions.
If possible, the shared branch review team should include

knowledgeable and qualified individuals to review the IS (i.e., an
IS&T SME or IS auditor). A specialized IS review, which includes
review of the system’scontrols and procedures, requires the
examiner-in-charge to plan for and coordinate qualified team
members well in advance of the review date.
Shared branch CUSO management should obtain independent,

periodic, IS processing audits. The examiner should obtain a copy
of the audit report and determine if management is correcting
exceptions, deficiencies, and weaknesses noted in the auditor’s
reports, management letters or other correspondence.
0 Regulatory compliance. The examiner should determine that the

shared branch CUSO complies with all necessary federal and state
laws and regulations.
Page 24A-6
Review report. At the conclusion of the shared branch CUSO

review, the examiner should prepare a review report. The report
may take the form of a letter to the shared branch CUSO
management, signed by the regional director and state supervisory
authority (if applicable). The examiner maintains a field file
containing the letter to the officials, all pertinent workpapers, and
the confidential section. AIRES workpapers designed for credit
union examinations will often not adapt to shared-branch CUSO
reviews. Examiners may choose to design their own workpapers
for these types of reviews.
As with any credit union examination, examiners should discuss

findings with management as they discover questions or problems.
Examiners should further discuss any resulting recommendations
with management before issuing the final report to the officials. In
the case of CUSOs involving FISCUs, examiners should follow
regional policy for communicating issues to CUSO management.
References NCUA Rules and Regulations

Part 712, Credit Union Service Organizations (CUSOs)
Page 24A-7
SHARED BRANCH CUSO REVIEW PROCEDURES =
APPENDIX 241)
Strategic Review cost trends (e.g., per transaction)
Risk a Review operational costs per transaction (e.g., increasing or
decreasing)
If costs are increasing, inquire as to whether management has
alternative programs planned (e.g., emphasis on ATMs to limit
labor costs)
Review the extent of the CUSO’s lending services
Review a sample of contracts with various credit unions involved
in the lending program
Transaction Perform general ledger review

Risk Review accuracy of material adjustingjournal entries
Review appropriateness of the branch accounting procedures
a Inquire about contingency plans including backup systems,
procedures, and authorization for member transactions when the
Information System is off line
Review Information System contracts, controls, and adequacy of
output information
Review internal controls for completeness, adequacy, and
consistency throughout the shared branch network
In the absence of an internal control function, review compensating
controls (particularly in the cash area)
If on-site contacts are performed at CUSO branches:
- Review control of cash, money orders, travelers checks, and
other negotiable instruments
- Review ATM and night depository procedures and controls
- Spot check teller cash reconcilements
- Inquire about tellers’ use of bait money, responsibility for this
area, and frequency of bait money review
- Review access and controls of passwords, keys, etc.
- Inquire about controls to prevent staff from performing
transactions on their own accounts and accounts of family
members
Page 24B-1
EXAMINER’S GUIDE
Review CUSO’s loan application approval process for compliance

with individual credit union’s lending policies
0 Review membership controls, verifications, and disbursement
procedures
0 Review consumer regulation compliance procedures
0 Review compliance with terms and conditions of the contract
Compliance 0 Review procedures to verify credit union membership

Risk 0 Review procedures to safeguard release of information about credit
union members
0 Review compliance with:
- Currency and foreign transactions
- Posting of NCUA and/or other applicable insurance
- Member confidentiality
- The participating credit unions must ensure they closely
monitor the activities of the shared branch CUSO operation to
mitigate these risks
Page 24B-2
Chapter 25
CREDIT UNION SERVICE ORGANIZATIONS
TABLE OF CONTENTS
CREDIT UNION SERVICE ORGANIZATIONS .......................................................... 25-1

CUSO Review Objectives.................................................................................... 25-1
Overview............................................................................................................. .25.2
Services ............................................................................................................... .25.3
CUSO Reviews .................................................................................................... 25-4
Purpose............................................................................................................... 5-5
Preparation .......................................................................................................... .25-5
Review of Operations and Management ............................................................ ..2 5-7
Review of Services .............................................................................................. 25-8
Financial Condition . . .............................................................................................. 25-8
Accounting Audit ................................................................................................ .25- 10
Controls................................................................................................................ 25-1 1
Data Processing .................................................................................................... 25-1 1
Privacy of Consumer Financial Information ........................................................ 25-11
Maintaining Legal Separation............................................................................. .25- 12
Impairment Assessment .......................................................................................2 5-15
Report Format ..................................................................................................... .25- 15
Supervision .......................................................................................................... 25-16
Suggested Procedures ........................................................................................ ..25- 16
References ............................................................................................................ 25-17
APPENDIX 25A - Sample CUSO Review ...................................................................... 25A-1
APPENDIX 25B - Financial Liquidity Ratios ................................................................ 25B-1
Chapter 25

CUSO Review 0 Determine that the credit union’s investment in and loans to a
Objectives CUSO comply with Part 7 12 of NCUA Rules and Regulations
Determine that the CUSO engages in permissible activities or
services
0 Determine the degree of risk the CUSO poses to the affiliated
credit union
Determine the ongoing feasibility of the CUSO
0 Determine the CUSO is in compliance with the Privacy Act
Associated 0 Interest rate risk - improper pricing of products and services

Risks constitutes the leading cause of interest rate risk;
0 Liquidity risk - improper pricing and poorly timed duration can
cause liquidity risk;
0 Reputation risk - poor decisions by the CUSO can reflect poorly
on the member and third-party perception of the credit union;
0 Strategic risk - ineffective planning of the products, services, and
pricing policies can result in strategic risk;
0 Credit risk - credit risk can occur when the CUSO fails to meet its
obligations;
0 Transaction risk - improper transaction processing and controls of
share account types and processing failures can cause other risks
(e.g., interest rate risk, liquidity risk); and
0 Compliance risk - inadequate or ineffective compliance policies
regarding account disclosures for applicable consumer compliance
regulations can result in loss exposure.
Specific activities undertaken by the CUSO and the amount of funds

invested in or loaned to the credit union may magnifL these risks.
Strategic risk applies in all CUSOs, because if the board has not
properly planned, and the CUSO has taken on excessive risk, losses
can damage the credit union’s profitability, net worth, and reputation.
Transaction, credit, and liquidity risks can affect the credit union’s
ability to continue to offer the services (provided by the CUSO) to its
Page 25-1
EXAMINER’S GUIDE
members. These can also negatively impact the financial condition and
reputation of the credit union.
Overview A credit union service organization (CUSO) is a corporation, limited

liability corporation, or limited partnership that provides services
primarily to credit unions or members of affiliated credit unions. Part
7 12 of NCUA’s Rules and Regulations authorizes federal credit unions
to invest up to one percent of unimpaired capital and surplus in
CUSOs andor to loan up to an aggregate of one percent of unimpaired
capital and surplus to CUSOs.
A CUSO’s organizational requirements, i.e., corporation (established

and maintained under federal or state law), limited liability
corporation, or limited partnership (an FCU may only participate in a
limited partnership as a limited partner), limit the risk of loss to the
affiliated credit unions to each credit union’s loan andor investment in
the CUSO. However, the loss of a CUSO service could affect the
operations and financial condition of affiliated credit unions beyond
their one percent investment in andor one percent loan to the CUSO.
CUSOs exist as separate legal entities chartered under state law

(except that a corporation may also be established under relevant
federal law). NCUA neither charters nor insures CUSOs; therefore,
they are not subject to NCUA regulations and credit union-type
examinations. CUSOs must comply with applicable state laws,
including state licensing and regulated activities’ laws.
NCUA does have contractual rights of “complete access to any books

and records of the CUSO and the ability to review CUSO internal
controls . . .” For this reason, the term “CUSO review” appears
throughout this chapter. NCUA performs CUSO reviews when safety
and soundness concerns to affiliated credit unions may exist.
Examiners perform CUSO reviews in a consensual manner in
cooperation with CUSO management when NCUA deems the CUSO
may pose an undue risk to the National Credit Union Share Insurance
Fund (NCUSIF).
In instances when disputes arise between the examiner and a CUSO

over access to books and records or problem resolution, the examiner
Page 25-2
should look to the supervisory examiner and regional policy for

guidance on resolution. Examiners should take a professional,
reasonable approach with CUSO management and consult their
supervisors if they encounter circumstances that they cannot
cooperatively resolve with CUSO management. Examiners should
tailor review procedures according to the size, complexity, and
business of the CUSO.
Services Unless safety and soundness concerns exist, an FCU may invest in,
loan to, or contract with CUSOs sufficiently bonded or insured for
their specific operations. The CUSO must engage in the preapproved
activities and services related to the routine daily operations of credit
unions.
The NCUA Rules and Regulations speifies and categorizes all services
that CUSOs may perform. Categories of permissible services include:
checking and currency services; clerical, professional, and
management services; consumer mortgage loan origination; electronic
transaction services; financial counseling services; fixed asset services;
insurance brokerage or agency; leasing; loan support services; record
retention, security, and disaster recovery services; securities brokerage
services; shared credit union branch (service center) operations;
student loan origination; travel agency services; trust and trust-related
services; real estate brokerage services; and CUSO investments in non-
CUSO providers. (The listings under the broad categories shown in
$712.5 serve illustrative purposes and are not an exclusive or
exhaustive list of permissible activities.)
The credit union must ensure that the services provided by the CUSO
meet the requirements of the Privacy Act. The contractual agreement
between the CUSO and the credit union should specifically limit
access and distribution of members’ records to accomplish compliance
under the Privacy Act. The credit union must pay particular attention
to the CUSO’s privacy policies and procedures to determine
compliance with all applicable laws and regulations on disclosure of
members’ information. Information that the credit union shares with
the CUSO should also comply with privacy regulations.
Page 25-3
EXAMINER’S GUIDE
The cyber financial services that CUSOs may provide (under the
electronic transaction services) to credit unions and their members
include electronic delivery of any permissible CUSO service and
electronic delivery of any permissible credit union service.
An FCU that wants to invest in or loan to a CUSO that offers an

unpreapproved activity or service must seek an advisory opinion from
NCUA’s Office of General Counsel regarding whether the proposed
activity falls within one of the authorized categories without filing a
petition to amend the regulation. If General Counsel determines that an
authorized category does not cover the activity in question, the credit
union must petition the NCUA Board to amend the regulation. The
request for petition must comply with the following:
Request NCUA Board approval and include an explanation and

documentation of the activity or service and how that activity or
service is associated with routine credit union operations;
Submit request jointly to regional office and to the Secretary of the

NCUA Board.
CUSO Examiners may consider recommending a CUSO review if, during an

Reviews examination of an affiliated credit union, the following questions
arose:
0 Is the CUSO operation adversely affecting the financial condition

and operation of the credit union?
0 Does the financial condition of the CUSO significantly affect the

operations of a credit union or group of credit unions that depend
on the CUSO’s services?
0 Is the credit union taking appropriate steps to ensure that the

CUSO operates as a separate entity thus limiting the credit union’s
risk exposure?
0 Is the credit union board of directors ensuring the CUSO’s separate

entity status?
Page 25-4
0 Is credit union or CUSO management involved in any conflicts of

interest as described in 5712.8 of the regulation?
Are the services offered permissible (see $712.5)?
Did the affiliated credit union obtain a written agreement from the
CUSO, before investing in or lending to the CUSO, that provides
for compliance with 5712.3(d)?
0 Does the CUSO obtain an annual certified public accountant

(CPA) audit?
0 Did the CPA note substantive operational or financial problems?
Purpose Examiners perform a CUSO review to determine the degree of risk the
CUSO poses to affiliated credit unions. Following are several steps
that may assist the examiner in determining such risk:
Assessing the financial condition of the CUSO;

0 Verifying the accuracy of the financial statements;
0 Assessing the adequacy of controls;
0 Determining the viability of operations and service to the member
credit unions; and
0 Confirming compliance with applicable laws and regulations.
Preparation Before conducting a CUSO review, the examiner must understand the
services offered, market trends and conditions, and service viability.
The Reference section of this chapter contains reference sources that
may familiarize the examiners with acceptable practices for a specific
service offered. As examiners become familiar with a CUSO’s internal
operations, the examiner may need to update or modify the review
procedures to achieve a more effective review. Examiners may
consider the following when preparing for a CUSO review:
0 Initial Contact. Once the region determines that the potential risk
posed by the CUSO warrants a review and obtains the necessary
regional approval, an NCUA regional representative should contact
the president or chairman of the CUSO to discuss the purpose of
Page 25-5
EXAMINER’S GUIDE
the upcoming review, schedule a mutually agreeable date, and

request basic financial and audit information needed for the review.
After agreeing upon the date, the examiner may draft a letter to the
CUSO confirming the date of the review and providing a list of
items needed for the review.
State Supervisory Authority (SSA). When NCUA decides to

proceed with a review of a CUSO that also serves state-chartered
credit unions, an NCUA regional representative contacts the SSA
to (1) convey its concerns, (2) request information that the state
may have regarding the operations of the CUSO, and (3) invite the
SSA’s participation on the CUSO review. SSAs often have special
CUSO review reports, which the examiner may benefit from
reading before proceeding with a CUSO review. To avoid
duplication of effort and unnecessary regulatory burden, NCUA
should use information provided by the SSAs’ CUSO review
reports whenever possible.
Team. Choosing qualified team members is important. For

example, examiners that have accounting, finance, outside audit
experience or expertise in the areas of the CUSO’s operation will
benefit the CUSO team.
Review. The examiner-in-charge develops a review program

emphasizing areas of immediate concern as well as covering
general operations, financial condition, management, and corporate
separateness (see Appendix 25A for a sample CUSO review.)
The extent of the tests performed vary relative to the nature of the
services offered and risks involved. However, the following steps
may assist the examiner in becoming familiar with the CUSO’s
operation and developing an initial review:
- Obtain knowledge of the industry in which the CUSO operates;

- Obtain general information about the CUSO’s business (e.g.,
requesting an organization chart, business plan);
- Review the field file of an affiliated credit union for any prior
information regarding CUSO policies;
- Review prior CUSO examination and audit results;
Page 25-6
- Determine the existence of related party transactions;

- Determine the need for outside specialists (e.g., information
systems specialist);
- Develop a review strategy;
- Write a review program that places primary emphasis upon
weaknesses noted in reviewing the CUSO’s operations,
facilities, and financial condition; and
- Request a tour of the CUSO facilities.
The extent of operational tests performed for the CUSO review

vary relative to the services offered by the CUSO (e.g., data
processing, share draft clearings, leasing, etc.). Therefore, the
examiner should exercise flexibility and innovation in preparing
and modifying the review to the services and operations of the
cuso.
Review of When performing an onsite review of the CUSO’s operations, the

Operations examiner may inquire about the CUSO’s managerial controls and
and about the CUSO’s working arrangements with leagues or trade
Management associations. The following guidelines may assist the examiner’s
review of operations and management:
0 Management. The examiner may arrange to review the CUSO’s

policies, procedures, budgets, business plan, goals and objectives,
reporting processes, articles of incorporation, and bylaws. The
examiner may discuss with management the nature and extent of
managerial planning, the overall reasonableness of the business
plan, and budgetary projections.
0 Business Plan. Good business planning involves management’s

development of a written business plan before the organization
begins doing business. A CUSO’s business plan should, at a
minimum, include (1) a statement of goals (including profitability
goals) and objectives; (2) policies, procedures, and timeframes for
achieving the goals and objectives; (3) budget projections
demonstrating management’s efforts to meet profitability and
capitalization goals, and achieve (and maintain) self-sufficiency;
and (4) monitoring techniques to inform management of the
operation’s status. Management should revise and update the
Page 25-7
EXAMINER’S GUIDE
business plan as necessary to keep it current. (A CUSO’s well-

developed and maintained business plan provides affiliated credit
unions a valuable resource for making decisions about permissible
investment and lending decisions.)
Managerial Personnel. An onsite CUSO review provides the

examiner an opportunity to observe and ascertain management’s
ability to effectively direct and control the CUSO’s operations. As
part of the review of key personnel, the examiner may find it
helpful to request resumes and employee evaluations and to detail,
in the working papers, background information of key management
officials. (State laws may affect disclosure of staff evaluations.)
The necessary experience and education for key personnel depends
on the types and levels of service the CUSO offers. NCUA’s
CUSO review report should note observed managerial weaknesses.
0 Minutes. The examiner reviews board minutes for content,

decisions, and required frequency of meetings according to the
CUSO’s bylaws. If available, the examiner may also request other
minutes, including those of userklient meetings, special meetings,
and executive committee meetings.
0 Investment and Loan Documents. The examiner reviews

investment and loan documents and CUSO agreements with
affiliated credit unions.
Review of The examiner should determine that the CUSO follows the regulation
Services in performing permissible services and serving primarily credit unions
or their members.
The CUSO’s quality of services provides information about the

ongoing feasibility of the CUSO. If available, membership surveys,
complaint departments, and third-party studies can assist the examiner
in assessing the quality of services.
Financial Examiners evaluate the CUSO’s financial condition to (1) determine

Condition its ability to meet its goals, objectives, and financial projections; (2)
analyze its prospects for future success; and (3) assess the risk to
Page 25-8
affiliated credit unions. Financial trends for a start-up operation are

often misleading; therefore, when calculating trends, the examiner
must differentiate between start-up CUSOs and those with several
years’ experience (e.g., cash flow projections, since CUSOs expense
start-up costs as they incur the costs.) The following areas may assist
examiners in the review of financial condition:
0 Trend Analysis. The financial analysis of a CUSO resembles that

performed during credit union examinations using the Financial
History and Key Ratios workpapers; however, some ratios used to
evaluate CUSOs differ from those used for credit unions (see
Appendix 25B for suggested key CUSO financial ratios.) To better
understand the CUSO’s trends and ratios, examiners may request at
least three years’ financial data. Comparative ratios (both over the
prior three years and to industry averages) assist the examiner in
determining the reasonableness of the CUSO’s current financial
condition. Both Dun & Bradstreet (www.dnb.com) and Robert
Morris Associates (www.rma.org) publish industry averages.
0 Profitability. Because of tax consequences, CUSO profitability

objectives may differ from those of credit unions; however,
CUSOs still require sufficient cash flow to meet their objectives.
Examiners analyze earnings to ensure their sufficiency to pay for
services offered, while achieving profitability and capital goals.
Examiners should know that in non asset-based CUSOs many

expenses incurred are a function of sales and, therefore, directly
relate to sales. To ensure meaningful ratios and trends in these
credit unions, examiners should compare expenses to sales.
0 Cash Flow. Profitable corporations, including CUSOs, do not

always have positive cash flow. This is more often true in the
initial or start-up stages, but can also result from mismanagement.
Conversely, since CUSOs hope to reduce taxes by minimizing net
income without affecting cash flow, CUSOs may not show a profit,
but have positive cash flow.
To analyze cash flow, examiners may request cash flow statements.

If the CUSO does not prepare cash flow statements and cash flow
appears to be a problem, examiners should analyze the cash flow
Page 25-9
EXAMINER’S GUIDE
position to ensure the CUSO has sufficient cash flow to maintain

normal operations. Depending on its severity, negative cash flow
may require the examiner to expand review, discuss the situation
with CUSO management, and develop (with CUSO management)
a plan to reverse the trend.
Taxes. As taxable entities, CUSOs should adjust their projections

for their tax liabilities. During the review, the examiner may
request a copy of the CUSO’s IRS filings (and documentation of
other local, state, or municipal tax liabilities) for review of proper
payment and inclusion in the supporting work papers.
Accounting Determining the extent of the review of the CUSO’s accounting and
Audit audit requires that examiners use judgment in the following areas:
0 General Ledger. The examiner requests for review the audit report,
notes to the audit report, engagement letter, report of reportable
conditions (if available), and other correspondence before
determining the extent of the general ledger review. If the
examiners do not question the CPA’s competence and
independence, they may place greater reliance on the CPA’s work.
The examiner may decide to rely on the CPA’s work and not
perform a comprehensive general ledger review. In these instances,
examiners may limit their general ledger reviews to the areas of
concern. For example, the examiner may choose to review only the
CUSO’s tax filings and aging of receivables and payables, or only
the appropriateness of classification of accounting information
(e.g., expenses improperly capitalized or income improperly
recognized.) Examiners may want to pay particular attention to the
collectibility of accounts receivable. (If material uncollectible
receivables exist, NCUA may require affiliated credit unions to
reserve for their investments in and loans to CUSOs.)
0 Audit. The examiner reviews the most recent CPA opinion audit
report, notes to the audit report, engagement letter, report of
reportable conditions (if available) and other correspondence with
the CPA. When examiners determine that the CPA is competent
Page 25-10
and independent, they may find a review of the workpapers

unnecessary.
When examiners believe reviewing the correlating audit

workpapers is necessary, they may request permission from the
CUSO to review the workpapers and ask the CUSO to make
necessary arrangements with the CPA firm. Review of audit
workpapers often provides meaningful information they cannot
obtain by simply reviewing the audit report (e.g., the CPA’s
assessment of the CUSO’s internal controls and a statement
regarding ongoing concern.)
Examiners should also confirm that the CUSO follows GAAP, as

required by $712.3(c) and $712.3(d)(l) of the regulation.
Controls The examiner’s onsite CUSO review may include assessing the
adequacy of internal controls necessary for the CUSO’s business.
Likewise, if the CUSO has an internal audit function, the examiner
may arrange to review the audit scope and procedures.
Data During an onsite review, the examiner may arrange to review the
Processing CUSO’s information processing system including related controls and
the disaster recovery plan.
Privacy of Part 7 16 requires that credit unions provide notice to their members
Consumer and consumers regarding the credit union’s privacy policies and
Financial practices for information provided to affiliated and nonaffiliated third
Information parties. The rule describes the conditions under which a credit union
may disclose nonpublic information about consumers to nonaffiliated
third parties. Finally, Part 716 provides for opting out, whereby
consumers may prevent a credit union from disclosing nonpublic
information to most nonaffiliated third parties.
An affiliate is a company that a credit union or a group of credit unions

controls. Examples include the following:
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EXAMINER’S GUIDE
0 For federally chartered credit unions, a credit union service

organization (CUSO) controlled by the credit union would
constitute the only affiliate. NCUA will presume a credit union has
a controlling influence over the management or policies of a
CUSO, if the CUSO is 67 percent owned by that credit union or by
that credit union and other credit unions; and
0 For federally insured state credit unions, an affiliate would include

a CUSO or another company controlled by the credit union.
A nonaffiliated third party is any person except:
0 The credit union’s affiliate; or
0 A person employed jointly by the credit union and any company

that is not the credit union’s affiliate.
Maintaining 5712.4 of the Rules and Regulations requires that a credit union
Legal investing in or loaning to a CUSO take reasonable steps to ensure that
Separation a court would not “pierce the corporate veil” and hold it liable for the
obligations of the CUSO. This can happen when (1) the corporation
(the CUSO) has insufficient assets to satisfy its debts, and (2) a parent
entity (the credit union) so closely identifies with the corporation that
justice requires holding the parent liable for those debts. The factors
courts look to in deciding whether to impose liability on the credit
union include inadequate capitalization of the CUSO, lack of separate
CUSO identity, common boards of directors and employees, control of
the credit union over the CUSO, and lack of separate books and
records. The following help determine these factors:
0 Whether CUSOs follow the corporate forms (holding meetings,

taking minutes, etc.);
0 Whether the CUSO’s management is distinct from the credit

union’s;
0 Whether the CUSO’s operations are distinct from the credit

union’s; and
Page 25-12
0 Whether the CUSO has adequate capitalization for its type of

business.
There is usually no single controlling component that the courts use in

determining whether to pierce the corporate veil
§712.4(b) requires a written attorney’s opinion stating that the CUSO’s

structure as a separate legal entity limits the credit union’s potential
exposure to no more than the loss of funds invested in and/or loaned to
the CUSO. The legal opinion should address the factors specified
above. Affiliated credit unions should obtain a new legal opinion if the
CUSO restructures its organization or if the operations of the CUSO
raise potential credit union liability issues.
The examiner should review the following items, which evidence that
the CUSO and the credit union function as separate entities. However,
the examiner may decide to forgo this review if through the scoping
process, the examiner has determined that the prior examiner reviewed
them, and no changes have subsequently occurred, or the annual CPA
audit of the CUSO indicates no material problems exist.
0 Articles of incorporation or partnership agreement filed with the

state;
0 Written bylaws;
0 Minutes of the first meeting of shareholders or partners or a

unanimous consent of the shareholders or partners electing the
board of directors;
0 Minutes of the first meeting of directors or a unanimous consent of

the directors electing officers and authorizing the issuance of the
shares and adoption of the bylaws;
0 Review of stock certificates;
0 Proof of capitalization and minimally adequate capital to support

the business plan; and
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EXAMINER'S GUIDE
A letter from an attorney licensed to practice in the state where the

CUSO principally operates opining that the CUSO's structure
limits the liability of the credit union to the investment in and/or
loan to the CUSO.
The following can aid the examiner in determining whether the CUSO
operates as a separate entity with sufficient financial resources of its
own and necessary distinction in management and operations:
Each ensures against intermingling of its respective business

transactions, accounts, and records (e.g., appropriate management
agreements, equipment leases, or real estate leases support
payments made by the CUSO to the credit union for rent, shared
employee costs, etc.);
0 Each observes the formalities of its separate corporate procedures

(e.g., each holds regular separate board meetings, each has separate
management);
Each is adequately financed as a separate unit in the light of normal

obligations reasonably foreseeable in a business of its size and
character (e.g., each has adequate capitalization in relation to its
business plan);
The public sees each as a separate enterprise (e.g., space that a

CUSO rents in the credit union should be separated from the credit
union operations with a separate mailing address and telephone
number, if possible);
0 The credit union does not dominate the CUSO to the extent that it
or the members treat the CUSO as a department of the credit
union; and
Except if the CUSO has a loan guaranteed by the credit union, all
borrowing by the CUSO indicates that the credit union is not liable
(i.e., the credit union does not provide guarantees to the CUSO
which could cause the credit union to incur liability in excess of the
permitted investment limitation in the regulation).
Page 25-14
Additionally, during onsite reviews, the examiner may arrange to

review the CUSO’s compliance with all other applicable regulations,
such as consumer regulations and state laws.
Finally, NCUA encourages CUSOs to maintain appropriate levels of

liability insurance and bonding. Management should periodically
review coverage to ensure adequate protection. In reviewing the
adequacy of bond coverage, examiners use their professional judgment
considering the CUSO’s type (e.g., shared branching CUSOs would
require similar coverage as credit unions), state law requirements,
industry standards, and insurance company recommendations.
Impairment Under GAAP, an “other -than-temporary” impairment in the credit

Assessment union’s CUSO investment (assuming a cost method CUSO
investment), requires a write down of the asset through the income
statement to a new cost basis. This new cost basis cannot be
subsequently written up for a recovery of value. The credit union
should consult its independent accountant if it suspects an “other-than-
temporary” impairment and provide the examiner with the independent
accountant’s assessment as it relates to GAAP. Examiners should
watch for the following “red flags,” which may indicate possible
“other-than-temporary” impairment:
0 Material negative cash flow resulting in an inability to meet

obligations;
0 Continual operating losses resulting in, or leading to, a deficit in

retained earnings; or
0 Piercing of the corporate veil.
Report The final report drafted by the examiner may include the following
Format work papers:
Open section:
- Narrative giving overall results of the CUSO review;
- Findings;
Page 25-15
EXAMINER’S GUIDE
- Conclusions and Recommendations; and

- Financial data and trends.
0 Closed section:
- Confidential section;
- Extent of CUSO risk-focused review (at examiner’s discretion,
they could include this in the open section); and
- Any other work papers needed to support the examiner’s
conclusions.
supervision When examiners discover material problems that may adversely affect
affiliated credit unions, the regional director may arrange with the
CUSO for supervision and follow-up measures commensurate with the
problems cited at the last contact. Supervision normally consists of
reviewing problem areas and weaknesses noted during the most recent
review. This should not imply that NCUA has the same supervision
authority over CUSOs as it has over credit unions. As with CUSO
reviews, supervision contacts are performed on a consensual basis
through the affiliated credit unions.
Supervision responsibilities vary depending on the equity and debt

structure of the CUSO. If the CUSO is a direct subsidiary of a credit
union or if all affiliated credit unions are in the same supervisory
examiner’s group, the supervision responsibilities logically would
remain with the supervisory examiner responsible for the credit union.
In other cases, however, the regional director or associate regional
director for programs assigns supervision responsibilities.
Suggested In addition to those already discussed, the following are suggested

Procedures procedures for performing a CUSO review once regional management
has approved the review:
0 At the close of the review, the examiners meet with the officials
and key management (exit conference) providing them with a draft
copy of the open section of the report (clearly labeled DRAFT).
The examiner invites the SSA to attend exit conferences of CUSOs
that also serve state-chartered credit unions;
0 The examiner submits to the region’s Division of Supervision:
Page 25-16
- The CUSO review report;

- All supporting work papers (including financial statements,
documentation specifying extent of the review, financial data
and trends, and a listing of all affiliated credit unions); and
- A final letter to the CUSO briefly describing the review
procedures, conveying the results and findings of the review,
and requesting a written response to the recommendations and
findings;
The regional office reviews the CUSO review report and letter for
quality control and submits the letter to the regional director for
approval;
0 When the CUSO has state-chartered credit union investors or

affiliated credit unions, the regional director furnishes a copy of the
CUSO review report to the SSA for comment before mailing the
open section to the CUSO. (Examiners should encourage CUSOs
to hold the report in confidence knowing, however, that CUSOs
have no obligation to confidentiality);
Once approved and signed by the regional director, the regional

office provides a copy of the CUSO review report to applicable
supervisory examiners, noting that the content is confidential. (In
the rare instance that a CUSO’s risk to its owner credit unions
requires a write-down of the asset, the regional director notifies the
owner credit unions in writing); and
0 When filing CUSO review reports, regional offices should cross

reference these CUSO review reports to the examinations of the
affiliated credit unions to give further credence to the fact that
NCUA performs CUSO reviews to assess risk to insured credit
unions.
References NCUA Rules and Regulations Part7 12

NCUA Rules and Regulations Part 7 16
Federal Financial Institutions Examination Council (FFIEC)
manuals (www.ffiec.gov);
Page 25-17
SAMPLE CUSO REVIEW APPENDIX 25A -
CUSO Reviews are performed in a consensual manner in cooperation with the
CUSO’s management. This review is not a required form; rather, it is intended to be a
guideline for examiners to complete as necessary.
The General CUSO Review applies to most CUSO operations. Specialized CUSO
Reviews contain additional procedures that examiners may use to review CUSOs
formed for a specific purpose.
CUSO OrganizationManagement
Review the articles of incorporation, bylaws, and mission statement
General
Review Review attorney’s opinion stating that the CUSO has been structured
as a separate legal entity (including any recommendations for
strengthening the corporate veil) to limit the liability of affiliated
credit unions’ investment in and/or loans to CUSOs
Review the limited partnership agreement and inquire as to whether

the CUSO is a limited partner
Inquire about the General Partner and the General Partner’s relation-
ship to affiliated credit unions if the CUSO is organized as a limited
partnership
Review the documentation of the limited liability corporation and

inquire as to whether this organizational structure is permitted by federal
or state law
Inquire as to whether the limited liability corporation provides

sufficient limits to the liability of affiliated credit unions’ investment
in and/or loans to CUSOs
Review whether the CUSO has funding guaranteed by afiliated

credit unions
Inquire as to whether there are contingent liabilities of the

CUSO that could directly affect affiliated credit unions
Review what steps have been taken to evidence to members, customers

and third parties that the CUSO and affiliated credit unions have
separate identities both in operation and management
Inquire whether CUSOs that offer non-deposit products (e.g., mutual

funds, annuities, insurance products, etc.) have adopted policies
and procedures to comply with NCUA Letter No. 150
Inquire about management interlocks
Page 25A-1
EXAMINER’S GUIDE
Inquire about primary users of CUSO services (i.e., that CUSO

primarily serves credit unions and/or membership of affiliated
credit unions)
Review permissibility of activities and services
Review business plan (including feasibility of goals and objectives)
Request organizational chart and job descriptions for management

and staff
Review qualifications and performance of management and officials
Review the CUSO’s policies and procedures manual
Review the board and committee minutes
Review supporting documents for credit unions with loans to

and/or investments in the CUSO
Request list of participating credit unions and other third parties

(including leagues and trade associations)
Review CUSO’s working arrangements with the league and trades
Review promotional materials and sample service agreements
Request information regarding member satisfaction with services

offered:
Review complaint department

Review any member surveys performed
Review any third party reviews
Request minutes of users’ meetings (if any)
Review management’s budgetary process
Review material contracts (e.g., management, data processing,

vendors, leases)
Financial Condition
Review feasibility of budget in conjunction with business plan goals
(including capitalization projections)
Review the statement of financial condition, statement of income,

and statement of changes in financial position
Review operating fee agreements with participating credit unions

for stable, reasonable, projected costs under various future operating
environments
Page 25A-2
SAMPLE CUSO REVIEW - APPENDIX 25A
Review projections for operating and capital costs, review

management’s capital requirements goals for compliance with SEC
capital requirements (where necessary)
Review the CUSO’s cash flow analysis
Request information about CUSO’s backup funding arrangements
Review CUSO’s exposure resulting from its reliance on one or

more credit unions
Compute key financial ratios (usually for past three years), analyze
financial trends and ratios, and compare trends and ratios with
industry averages
AccountingIAuditing
Perform general ledger review (as necessary):
Reconcile financial statements to general ledger

Reconcile major accounts to the subsidiary ledgers
Review recent bank reconciliations
Review major income and expense accounts
Review the accounts receivable and accounts payable
aging schedules
Review the adjusting entries to payable and receivable
accounts to and from member credit unions
Review valuation of assets and accuracy of financial statements
Review adequacy of allowance for doubtful accounts
Review notes to financial statements ( e g , for contingent liabilities

and outstanding commitments)
Review CUSO structure for “second tier” CUSO and review

functions
Review recent IRS tax filings and state and local tax filings
Review CPA audit report, the engagement letter, letter of reportable

conditions, contingency letter (make inquiries through present date)
and check for statement regarding ongoing concern
Review procedures for allocating operating costs and assessing

monthly fees and charges to member credit unions
Review sample of billing statements to credit unions
Review auditor’s verification of member credit unions’ investment

and loan balances
Page 25A-3
EXAMINER’S GUIDE
Internal Controls
Request internal auditor or audit committee procedures, work papers,
and other supporting documentation (if applicable)
Review for proper segregation of duties, vacation policy, supervisor

review process
Review access and password control procedures
Review CUSO’s procedures for verifying credit union membership
Review CPA’s assessment of CUSO’s internal controls (if problems

are noted)
Information Systems (IS) Processing

Review third party vendor IS audit (if available)
Review IS data security policies, procedures, and controls (e.g.,

limited access to the system)
Develop or review flow chart of IS system
Review reports generated and inquire about supervisory

management levels responsible for reviewing the reports
Review disaster recovery program (if available)
RegulationsLegal
Inquire about outstanding or pending litigation and probability of loss
Review bond coverage and other insurance coverage for reasonableness

and compliance with applicable state and federal requirements
Review CUSO’s practices as to compliance of the services performed

with applicable privacy laws and regulations
Review compliance with applicable consumer regulations
Review compliance with applicable state and federal regulations
Mortgage Additional Mortgage Services CUSO Review

Services Organization and Management
cuso Review the rate lock reports to ascertain if the CUSO is meeting
commitments
Review HMDA reports (if applicable)
Request a list of appraisers used by CUSO
Page 25A-4
Financial Condition
Review current status (and future assumptions) of the mortgage
pipeline and the promptness of processing loans
Inquire about the monthly minimum number of mortgage contracts

for the CUSO to be profitable
Review how changes in mortgage interest rates impact the mortgage

pipeline
Internal Controls
Review disbursement procedures
RegulationslLegal
Review compliance with consumer compliance regulations
(Reg B, Z, C, Reg X, HMDA, RESPA, Fair lending)
Shared Additional Shared Branch CUSO Review

Branch cuso Financial Condition
Review cost trends (e.g., per transaction)
Review operational costs per transaction (e.g., increasing or

decreasing)
If costs are increasing, inquire as to whether management has

alternative programs planned (e.g., emphasis on ATMs to limit
labor costs)
AccountingJAuditing
Perform general ledger review:
Review accuracy of material adjusting journal entries

Review appropriateness of the branch accounting procedures
Internal Controls
Review internal controls for completeness, adequacy, and
consistency throughout the shared branch network
In the absence of an internal control function, review compensating

controls (particularly in the cash area)
If on-site contacts are performed at CUSO branches:
Review control of cash, money orders, travelers checks, and

other negotiable instruments
Review ATM and night depository procedures and controls
Spot check teller cash reconcilements
Inquire about tellers' use of bait money, responsibility for this
Page 25A-5
EXAMINER’S GUIDE
area, and frequency of bait money review

Review access and controls of passwords, keys, etc.
Inquire about controls to prevent staff from performing
transactions on their own accounts and accounts of family
members
Review procedures to verify credit union membership
Review procedures to safeguard release of information about
credit union members
Inquire about backup systems, procedures, and authorization
for member transactions when the IS is off line
Lending (for service centers that perform lending services)

Review the extent of the CUSO’s lending services
Review CUSO’s loan application approval process for compliance

with individual credit union’s lending policies
Review membership controls, verifications, disbursement procedures
Review a sample of contracts with various credit unions involved

in the lending program
Review consumer regulation compliance procedures
Review compliance with terms and conditions of the contract

Review IS contracts, controls, and adequacy of output information
RegulationsLegal
Review compliance with:
Currency and foreign transactions

Posting of NCUA andor other applicable insurance
Member confidentiality
Information Additional Information Systems (IS) Processing Review

(Refer also to Information Systems and Technology chapter for guidance regarding
Systems information systems’ processing)
Processing
cuso Financial Condition
Review CUSO’s analysis of each cost center or branch (if
applicable) including the profitability of each segment
Review at least one actual service contract for each type of

service arrangement (e.g., on-line, in-house, disaster recovery)
Review contract expiration dates of institutions using the IS

processing system
Page 25A-6
Review the contracts’ expiration date schedules for impact of

potential nonrenewal of contracts
Internal Controls
Review internal controls in the computer operations area
Review operational procedures for adherence to the CUSO’s

formal policies
Review disaster recovery procedures including testing schedule

to ensure that backup procedures remain adequate and computer
service to credit unions will not be interrupted in case of disaster
Review access to CUSO computer operations (e.g.. limited to

authorized personnel)
Review methods used to confirm transactions

Request copy of the most recent third party review opinion and
review management’s response to weaknesses noted in the report
Review controls pertaining to access, passwords, keys, etc.
Review controls to prevent staff from performing transactions on

their own accounts or family members’ accounts
Review security logs for possible security breach attempts
Review procedures safeguarding release of information
Review intrusion detection procedures
Review backup systems and procedures
Inquire whether backup site is on a different grid from main office
Inquire about anticipated downtime (time needed to transfer major

records to backup system)
Review results of the most recent test of the backup system
RegulationdLegal
Review compliance with confidentiality of credit union members’ data
Page 25A-7
EXAMINER’S GUIDE
Auto Leasing Additional Auto Leasing CUSO Review

cuso Internal Controls
Review operational policies and procedures including purchase of
cars, establishment of capital cost amounts and residual values
RegulationslLegal
Review that CUSO’s contingent liability insurance policy contains
a specific endorsement for leasing
Review insurance contracts that pertain to the leased vehicle and

the strength of the insurance providers (e.g., ratings)
Review insurance policies including:
Residual value insurance - credit union should receive the principal

balance of the loan upon fruition of the lease term (NOTE:
residual value insurance is necessary if the residual value used
in the lease agreement is over 25 percent of the initial value
of the vehicle)
Gap insurance - protects the credit union from loss due to the
gap between the insurance company’s book value of the
vehicle and the credit union’s principal balance of the vehicle
in the event the car is stolen or wrecked beyond repair
Review insurance documents to ensure that all financed leased

vehicles are covered by the policies (NOTE: if documentation
does not specify the attachment of coverage to each individual
vehicle, an attorney’s opinion should be on file stating that
blanket policy covers all financed leased vehicles)
Review whether the CUSO’s insurance coverage is in compliance

with applicable state and federal requirements
Review compliance with Regulation M
Financial Additional Financial Services CUSO Review

(Includes Electronic Transaction Services, Financial Counseling Services, Real
Services Estate Brokerage Services, and Insurance Brokerage or Agency)
cuso
OrganizationManagement
Review employees’ compliance with licensing requirements
Inquire about training programs for the sale of nondeposit products

(i.e., that training is provided to all employees that have direct contact
with the members and imparts a thorough knowledge of the products
involved, applicable legal restrictions, and customer protection
requirements)
Inquire about the disciplinary actions in background of employees

hired for the sale of nondeposit products
Review the need for SEC filings
Review compliance with Employment Retirement Income Security

Act of 1974 if broker handles any retirement programs (e.g.,
credit union staff's pension)
RegulationsLegal
Review compliance with applicable sections of NCUA Letter No. 150
Review compliance with the following:
Currency and foreign transactions

Posting of NCUA or other applicable insurance
Leasing Review Leasing policies and procedures

Services Review contractual relationship between credit union and CUSO
regarding delivery of CUSO leasing services
Refer to Leasing -Internal Controls questionnaire for guidance in

reviewing leasing services
Trust and Review Trust Service policies and procedures

Trust Related Review Trust Agreements with clients/customers
Services
Review what steps are taken to ensure that the agreements are being
followed.
Review minutes of any Trust related committee meetings
Review Auditors' verification of Trust account assets
Review vendor contracts
Review compliance with member confidentiality
Review InsuranceBond coverage
Page 25A-9
FINANCIAL LIQUIDITY RATIOS APPENDIX 25B -
Liquidity is a measure of the quality and adequacy of current assets to meet current
obligations as they come due.
0 Current Ratio:
Total Current Assets
Total Current Liabilities
This ratio is a rough indication of a firm’s ability to service its current obligations.
Generally, the higher the current ratio, the greater the cushion between current
obligations and a firm’s ability to pay them. The stronger ratio reflects a numerical
superiority of current assets over current liabilities. However, the composition and
quality of current assets is a critical factor in the analysis of an individual firm’s
liquidity.
0 Quick Ratio (or Acid Test Ratio):

Cash & Equivalents + Net Trade Receivables
Total Current Liabilities
This ratio is a refinement of the current ratio and is a more conservative measure of
liquidity. It expresses the degree to which a company’s current liabilities are covered
by the most liquid current assets. Generally, any value of less than 1 to 1 implies a
reciprocal dependency on inventory or other current assets to liquidate short-term
debt.
0 SalesiReceivables:
Net Sales
Net Trade Receivables
This ratio measures the number of times trade receivables turn over during the year.
The higher the turnover of receivables, the shorter the time between sale and cash
collection. For example, a company with sales of $720,000 and receivables of
$120,000 would have a salesheceivables ratio of 6.0, which means receivables turn
over six times a year. If a company’s receivables appear to be turning slower than the
rest of the industry, further research is needed, and the quality of the receivables
should be examined closely.
One problem with this ratio is that it compares one day’s receivables, shown at
statement dates to total annual sales and does not take into consideration seasonal
fluctuations. Another problem in interpretation may arise when there is a large
proportion of cash sales to total sales.
0 Day’s Receivables:
365
SalesiReceivableratio
This figure expresses the average time in days that receivables are outstanding.
Generally, the greater number of days outstanding, the greater the probability of
delinquencies in accounts receivable. A comparison of a company’s daily receivables
may indicate the extent of a company’s control over credit and collections. The terms
offered by a company to its customers, however, may differ from terms within the
industry and should be taken in to consideration.
Page 25B-1
EXAMINER’S GUIDE
In the example above, 365 divided by 6 = 61 - i.e., the average receivable is collected
in 61 days.
0 Cost of Saleshnventory:
Cost of Sales
Inventory
This ratio measures the number of times inventory is turned over during the year.
High inventory turnover can indicate better liquidity or superior merchandising.
Conversely, it can indicate a shortage of needed inventory for sales. Low inventory
turnover can indicate poor liquidity, possible overstocking, obsolescence, or, in
contrast to these negative interpretations, a planned inventory buildup in the case of
material shortages. One problem with this ratio is that it compares one day’s
inventory to cost of goods sold and does not take seasonal fluctuations into account.
0 Day’s Inventory:
365
Cost of SalesAnventory Ratio
Division of the inventory turnover ratio into 365 days yields the average length of
time units are in inventory.
0 Cost of SalesRayables:
Cost of Sales
Trade Payables
This ratio measures the number of times trade payables turn over during the year. The
higher the turnover of payables, the shorter the time between purchase and payment.
If a company’s payables appear to be turning more slowly than the industry, then the
company may be experiencing cash shortages, disputing invoices with suppliers,
enjoying extended terms, or deliberately expanding its trade credit. The ratio
comparison of company to industry suggests the existence of these possible causes or
others. If a firm buys on 30-day terms, it is reasonable to expect this ratio to turn over
in appropriately 30 days.
One problem with the ratio is that it compares one day’s payables to cost of goods
sold and does not take seasonal fluctuations into account.
0 Day’s Payables:
365
Cost of Salesh‘ayables Ratio
Division of the payables turnover ratio into 365 days yields the average length of
time trade debt is outstanding.
0 Sales/Working Capital:
Net Sales
Net Working Capital
Working capital is a measure of the margin of protection for current creditors. It

reflects the ability to finance current operations. Relating the level of sales arising
from operations to the underlying working capital measures how efficiently working
capital is employed. A low ratio may indicate an inefficient use of working capital
--
while a very high ratio often signifies overtrading vulnerable position for creditors.
Page 25B-2
FINANCIAL LIQUIDITY RATIOS - APPENDIX 25B
Coverage Coverage ratios measures a firm’s ability to service debt.
Ratios 0 Earnings Before Interest and Taxes (EBIT) Interest:

Earninm Before Interest & Taxes
Annual Interest Expense
This ratio is a measure of a firm’s ability to meet interest payments. A high ratio may
indicate that a borrower would have little difficulty in meeting the interest obligations
of a loan. This ratio also serves as an indicator of a firm’s capacity to take on
additional debt.
0 Net Profit, Depreciation, Depletion, AmortizatiodCurrent Maturities Long-Term

Debt:
Net Profit + Depreciation + Depletion + Amortization Expenses
Current Portion of Long-Term Debt
This ratio expresses the coverage of current maturities by cash flow from operations.
Since cash flow is the primary source of debt retirement, this ratio measures the
ability of a firm to service principal repayment and is an indicator of additional debt
capacity. Although it is misleading to think that all cash flow is available for debt
service, the ratio is a valid measure of the ability to service long-term debt.
Leverage Highly leveraged f m s (those with heavy debt in relation to net worth) are more
vulnerable to business downturns than those with lower debt to worth positions.
Ratios While leverage ratios help to measure this vulnerability, remember they vary greatly
depending on the requirements of particular industry groups.
0 Fixed/Worth:
Net Fixed Assets
Tangible Net Worth
This ratio measures the extent to which owner’s equity (capital) has been invested in
plant and equipment (fixed assets). A lower ratio indicates a proportionately smaller
investment in fixed assets in relation to net worth, and a better cushion for creditors
in case of liquidation. Similarly, a higher ratio would indicate the opposite situation.
The presence of substantial leased fixed assets (not shown on the balance sheet) may
deceptively lower this ratio.
0 Debt/Worth:
Total Liabilities
Tangible Net Worth
This ratio expresses the relationship between capital contributed by creditors and that
contributed by owners. It expresses the degree of protection provided by the owners
for the creditors. The higher the ratio, the greater the risk assumed by creditors. A
lower ratio generally indicates greater long-term financial safety. A firm with a low
debt/worth ratio usually has greater flexibility to borrow. In the future a more highly
leverage company has a more limited debt capacity.
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EXAMINER’S GUIDE
Operating Operating ratios are designed to assist in the evaluation of management performance.
Ratios % Profits Before TaxesITangibleNet Worth

Profit Before Taxes
Tangible Net Worth
This ratio expresses the rate of return on tangible capital employed. While it can
serve as an indicator of management performance, it should be used in conjunction
with other ratios. A high return, is normally associated with effective management
and could indicate an undercapitalized f m whereas a low return is usually an
indicator of inefficient management performance and could reflect a highly
capitalized, conservatively operated business. This ratio is multiplied by 100 since it
is shown as a percentage.
(NOTE: Profit before taxes may be zero, in which case the ratio is zero. Profits
before taxes may be negative resulting in negative quotients.)
0 YOProfit Before TaxedTotal Assets

Profit Before Taxes
Total Assets
This ratio expresses the pre-tax return on total assets and measures the effectiveness
of management in employing the resources available to it. If a specific ratio varies
considerably from industry standards, the analyst will need to examine the makeup of
the assets and take a closer look at the earnings figure. A heavily depreciated plant
and a large amount of intangible assets or unusual income or expense items will
cause distortions of this ratio. This ratio is multiplied by 100 since it is shown as a
percentage.
Salesmet Fixed Assets

Net Sales
Net Fixed Assets (Net of Accumulated Depreciation)
This ratio is a measure of the productive use of a firm’s fixed assets. Largely
depreciated fixed assets or a labor intensive operation may cause a distortion of this
ratio.
Sales/Total Assets
Net Sales
Total Assets
This ratio is a general measure of a firm’s ability to generate sales in relation to total
assets. It should be used only to compare firms within specific industry groups and in
conjunction with other operating ratios to determine the effective employment of
assets.
Expense to The following two ratios relate specific expense items to net sales and express this
relationship as a percentage. Comparisons are convenient because the item, net sales,
Sales Ratios is used as a constant. Variations in these ratios are most pronounced between capital
and labor intensive industries.
Page 25B-4
FINANCIAL LIQUIDITY RATIOS - APPENDIX 25B
0 % Depreciation, Depletion, AmortizatiodSales

DeDreciation, Amortization. Depletion Expenses
Net Sales
This ratio is the annual depreciation, amortization, and depletion expenses divided by
net sales and multiplied by 100.
0 % Officers’, Directors’, Owners’ CompensatiodSales

Officers’. Directors’. Owners’ Compensation
Net Sales
Annual officers’, directors’, owners’ compensation divided by net sales and

multiplied by 100. Included here are drawings of partners and proprietors, total
salaries, bonuses, commissions, and other monetary remuneration to all officers;
directors; and owners of the firm during the year covered by the statement.
Page 25B-5
Chapter 26
FEDERALLY INSURED STATE-CHARTERED
CREDIT UNIONS (FISCUS)
TABLE OF CONTENTS
FEDERALLY INSURED STATE-CHARTERED CREDIT UNIONS (FISCUS) .........26-1

Insurance Review Objectives ............................................................................... 26-1
Risk Categories ................................................................................................... . 26. 1
Overview............................................................................................................. . 26. 1
Monitoring Insured Credit Unions ...................................................................... .26.2
Criteria for Onsite Reviews ................................................................................. 26-3
Planning an Onsite Contact.................................................................................. 26-4
Types of Onsite Reviews ..................................................................................... 26-4
Onsite Procedures ................................................................................................ 26-5
Assignment of CAMEL ....................................................................................... 26-7
Joint Examination and Insurance Review Reports ............................................. .26.8
Joint Conferences .................................................................................................2 6-9
Supervision of FISCUs ....................................................................................... .26- 10
Prompt Corrective Action ................................................................................... .26- 10
Problem Credit Unions ....................................................................................... .26-11
APPENDIX 26A - Application and Agreement for Insurance ....................................... . 2 A- 61
Chapter 26
FEDERALLY INSURED STATE-CHARTERED CREDIT

UNIONS (FISCUS)
Insurance 0 To work cooperatively with state supervisory agencies to assess the
Review financial and operational condition of federally insured state-
Objectives chartered credit unions (FISCUs)
0 To address material risk in FISCUs that may negatively affect the

NCUSIF
Risk FISCUs, like all credit unions, are subject to the seven categories of
Categories risk, discussed in the Risk-Focused Program chapter. These risks
include Credit, Interest Rate, Liquidity, Transaction, Compliance,
Strategic, and Reputation. As with other credit unions, FISCUs have
the obligation to mitigate their risk to the NCUSIF by implementing
measures such as management’s due diligence, sound internal controls,
the audit process, and well-trained management and staff. The size and
complexity of the credit union should determine the extent of these
risk mitigation measures.
Overview The National Credit Union Share Insurance Fund (NCUSIF) provides
the same account insurance coverage to FISCUs as to federal credit
unions. However, the means of monitoring insurance risk differs.
NCUA recognizes state supervisory agencies as the government
agencies primarily responsible for the supervision of insured state
credit unions. State regulators normally share parts or all of the state
examination reports or audits with the appropriate NCUA regional
office.
When applying for federal share insurance, state credit unions sign an
Agreement for Insurance of Accounts and agree to follow Part 741 of
NCUA’s Rules and Regulations. Appendix 26A contains a copy of the
Agreement.
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EXAMINER'S GUIDE
Each regional office and the respective state supervisory authority

(SSA) create their own working relationships and agreements to
accommodate the unique circumstances of each state. The agreements
must contain provisions for periodic meetings, and the sharing of
credit union information and insurance concerns.
These agreements with each SSA will determine how NCUA will
communicate an insurance concern to the SSA, and may cause a
variation to the procedures in this chapter. Communication between
the region and each SSA may be as informal as periodic telephone
calls or as structured as monthly written status reports or quarterly
meetings.
The periodic meetings between regional management and each SSA

will include (1) discussion of current issues, (2) review of existing or
potential problem FISCUs, and (3) scheduling or coordination of
scheduling onsite insurance examinations, reviews, and supervision
contacts. After each meeting with the SSA, the region should evaluate,
update, and reduce to writing the individual programs to reflect current
agreements with each state.
NCUA limits its concerns to insurance risk, which includes safety and
soundness issues that could have a material effect on the FISCU's
operation. Specific safety and soundness areas to address, in addition
to those discussed in Part 741 of the NCUA Rules and Regulations,
include each of the seven risk areas identified in the Risk-Focused
Program chapter.
NCUA's concerns include the following:
0 The examiners adequately addressed material risks with the

FISCUs;
0 The credit union understands the seriousness of the risks; and
0 An agreement or plan exists for resolving unacceptable risks in a
timely manner.
Monitoring The primary ways by which NCUA monitors the financial condition
Insured and the progress of FISCUs are through the district examiner's review
Credit Unions
Page 26-2
FEDERALLY INSURED STATE-CHARTEREDCREDIT UNIONS (FISCUS)
of examination reports completed by the SSA, 5300 Call Reports, the

scope workbook, and the Financial Performance Reports (FPRs.)
State regulators provide copies of their examination reports to the

respective NCUA regional office and upload completed scope
workbooks to the NCUA server. The NCUA examiner independently
reviews the report and scope workbook offsite to ensure they
document the following:
Identification of all material risks that may negatively affect the

NCUSIF or the safety and soundness of the FISCU;
Recommendation for corrective action that adequately addresses
the potential insurance risk for such material risks;
0 Establishment of reasonable timeframes for implementation; and
0 Determination that the credit union is sufficiently progressing
toward correcting previously noted problems (where applicable.)
Additional tools for monitoring FISCUs may include periodic receipt

and review of the credit union’s financial statements, attention to the
news media, risk management reports using call report data, and
discussions with the credit union officials, trade organizations, and the
SSA. These sources may alert the SSAs, regional office, and examiner
staff to adverse conditions affecting an individual credit union or a
group of credit unions that serve a specific geographic area or a
particular type field of membership.
These monitoring tools may trigger regional communication with the

SSA for more information, revision of the scope workbook, and
possible inclusion of the credit union in hture onsite contacts. If these
monitoring measures indicate no severe risks, NCUA usually does not
require or take further action.
Criteria for The SSA and NCUA share responsibility for developing mutually
Onsite satisfactory criteria and procedures for scheduling and completing
Reviews onsite insurance reviews. Reasonableness should govern NCUA’s
requests to conduct insurance reviews.
The fundamental purpose for onsite insurance reviews is to assess risk

to the NCUSIF. To that end, NCUA will schedule FISCUs for onsite
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EXAMINER'S GUIDE
reviews based on risk factors of individual credit unions. For example,

large credit unions, due to the concentration of assets, represent a
substantial risk to the NCUSIF that necessitates greater oversight,
including more frequent insurance reviews and supervision.
Secondarily, NCUA performs its due diligence by selecting FISCUs as
needed to assure a certain percentage of credit unions of varying size,
complexity, and risk profile receive onsite reviews.
NCUA, as the administrator of the NCUSIF, has the legal and

fiduciary responsibility to ensure the safety of the NCUSIF. Therefore,
NCUA reserves the right to conduct an insurance review of any
federally insured credit union if necessary to determine its condition
for insurance purposes.
Planning an When planning an onsite contact in a FISCU, NCUA staff will consult
Onsite with the SSA before contacting state credit union officials. Working
Contact agreements between the regional offices and individual SSAs have
established defined procedures for various types of contacts and means
of communicating information concerning risk areas that may affect
the FISCUs in their jurisdictions. However, when examiners perform
an onsite contact in a FISCU, they will explain to management and the
officials the purpose for the contact and the reason for NCUA's
involvement.
Types of The two most common types of onsite FISCU reviews are an
Onsite independent insurance review and a joint examinatiodinsurance
Reviews review. An independent insurance review differs from a joint
examinatiodinsurance review. In both, NCUA limits the scope of an
insurance review to risk issues negatively affecting the NCUSIF, and
does not address regulatory issues except as they relate to safety and
soundness concerns.
During an insurance review in a FISCU, the NCUA examiners limit

their role to the review and analysis of existing or potential risks to the
NCUSIF only, rather than to complete an examination of the FISCU.
Should the examiners uncover other safety and soundness problems
during an insurance review, they should also address these problems.
Therefore, NCUA will discuss with the SSA safety and soundness
Page 26-4
FEDERALLY INSURED STATE-CHARTERED CREDIT UNIONS (FISCUS)
issues that require addressing and resolving, and will ensure that either
the state or NCUA examiner discusses these issues with the credit
union.
In joint examinations/insurancereviews, both NCUA and the SSA

focus on risk issues (including safety and soundness issues,
commensurate with the size, complexity, and risk profile of the credit
union), while the state examiner focuses additionally on regulatory
concerns.
Onsite NCUA conducts an onsite insurance review in one of the following

Procedures formats:
0 Joint examinatiodinsurance review - performed concurrently or

jointly with the SSA. In most cases, the working agreement
developed by the regional office and each respective state contains
agreed-to procedures for joint examinations.
In all joint examinations/insurancereviews, unless otherwise

agreed to by the SSA, the SSA examiner will act as the examiner in
charge. This means that the SSA examiner assumes responsibility
for the scope workbook and leads all of the discussion with the
credit union officials. Within the parameters of the working
agreements, the SSA examiner in charge defines the scope of an
individual FISCU examination, considering all relevant factors,
including NCUA's concerns.
NCUA, as administrator of the NCUSIF, will ensure satisfactory

addressing of the risk factors that affect or potentially affect the
NCUSIF. Otherwise, NCUA may need to express its concerns to
the SSA in a joint meeting. NCUA examiners should contact their
supervisory examiners and follow regional guidance if
disagreements arise. If NCUA cannot agree to the scope of a joint
examinatiodinsurance review based on risk factors in the FISCU,
it will conduct an independent insurance review.
The goal of the joint examinatiodinsurance review is to (1) assess

the risk in the credit union, (2) address the credit union's risks to
the satisfaction of both the SSA and NCUA, and (3) ensure the
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EXAMINER'S GUIDE
credit union adequately mitigates the risk. Responsibility for the

scope workbook rests with the SSA examiner in charge.
0 Insurance review - independently performed by NCUA staff.

NCUA determines the scope of the insurance review, which it
normally limits to insurance risk, including safety and soundness
issues. NCUA generally does not address regulatory issues unless
they present a risk that may affect the NCUSIF. For example, even
though NCUA does not have responsibility for enforcing
Regulation Z, Truth in Lending, with respect to state-chartered
credit unions, a credit union could incur money penalties resulting
from violations of Regulation Z that may result in losses for the
credit union.
Rather than performing just an insurance review, NCUA will perform

a complete examination if the SSA so requests and NCUA agrees to
the SSA's request. In these cases, NCUA assumes responsibility for
the scope workbook.
Whenever possible, NCUA schedules onsite insurance reviews in

conjunction with state examinations. NCUA will remain as flexible as
possible in working with the SSA, but not to the extent that risk to the
NCUSIF increases. NCUA limits its examination steps to a review of a
FISCU's insurance risk.
NCUA examiners should avoid duplication of the SSA's effort during

a joint examinatiodinsurance review. The SSA examiner in charge
develops an examination plan outlining the division of work to address
insurance issues, safety and soundness concerns, and regulatory
requirements. The plan sets forth tentative timeframes for finishing
various examination steps. While an efficient examination necessitates
such a plan, both the plan and time should allow enough flexibility to
accommodate expanding (or reducing) the examination scope if
conditions in the credit union or preliminary findings so warrant.
The SSA and NCUA jointly assume responsibility for adequately

addressing safety and soundness issues and for coordinating with the
SSA examiner in charge any necessary corrective action. In a situation
where the state law or regulation does not prohibit, or is silent
regarding a policy or procedure that NCUA considers a violation of
Page 26-6
FEDERALLY INSURED STATE-CHARTEREDCREDIT UNIONS (FISCUS)
safe and sound practices, NCUA will take exception and, after
notification and review with the SSA, reach agreement for appropriate
corrective action. The treatment of the issue in the report depends on
its severity and materiality.
During a j oint examinatiodinsurance review or an independent

insurance review, and before meeting with credit union officials, state
and federal examiners jointly discuss their findings and
recommendations. Whether or not they reach agreement, state and
federal examiners share responsibility for striving to reach compatible
conclusions. Disagreements between NCUA and the SSA should not
occur at briefings with the officials, and examiners should take care
not to introduce topics during these meetings that they had not
previously discussed.
If examiners cannot reach mutual agreement, their supervisors will

attempt to resolve the disagreements before meeting with the credit
union officials. Both parties understand that NCUA has the appropriate
right to ensure that the SSA examiner in charge or a designee
addresses all significant findings, concerns and recommendations with
the credit union's officials and management, and communicates
expected corrective actions to officials and management during the
joint examinatiodinsurance review or independent insurance review.
This may result in NCUA voicing its own concerns in joint meetings;
however, NCUA should not voice its concerns without prior
discussions between the examiners' supervisors.
Assignment During an insurance review, the NCUA examiner will not discuss
of CAMEL CAMEL component or composite ratings with officials of the FISCU.
In states where the SSA assigns a CAMEL code, the code assigned by
NCUA may differ from that of the SSA. Since NCUA does not release
its code to FISCUs, the state's CAMEL code will be the only one the
credit union receives. NCUA will explain any differences from an
insurance perspective in the confidential section in accordance with
regional policy.
The SSA examiner generally assigns CAMEL codes in FISCUs toward

the end of an insurance review in a manner similar to the assignment
of CAMEL codes in federal credit unions. All FISCUs rated a code 4
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EXAMINER'S GUIDE
or 5 by NCUA must have proper regional management approval in

accordance with the region's policies.
Joint Reporting differs in a joint examinatiodinsurance review from a

Examination concurrent examinatiodinsurance review. During a joint
and examinatiodinsurance review, the SSA examiner and NCUA
Insurance examiner issue a single combined report to the FISCU. In a concurrent
Review examinatiodinsurance review, the SSA examiner and the NCUA
Reports examiner issue separate reports to the credit union officials.
A goal exists of a single report encompassing both state and NCUA

work. NCUA encourages examiners to jointly write the report and
avoid duplication of effort during the examination. However, whether
examiners issue a single report or two separate reports, the report or
reports must address the concerns of both parties and document plans
of action, developed with the credit union's officials and management,
to correct noted deficiencies.
NCUA examiners should not take issue with SSA reporting practices
merely because they differ from the standard NCUA examination
report format. The overriding concern remains that the credit union
officials receive sufficient direction to correct weaknesses and
problems. The procedure to accomplish this is secondary to the
effective communication of existing risks and necessary corrective
action. NCUA and SSAs (with few exceptions) have adopted the
AIRES examination program. Examiners may provide the credit union
with additional workpapers needed to supplement specific areas of the
examination.
Generally, the agreement enacted between each SSA and the respective
regional office governs if, how, and when NCUA releases the
examination report in that particular state. The region institutes
procedures for performing regional office reviews and supervisory
examiner appraisals of a joint examinatiodinsurance review report.
The time required for reviewing and appraising the reports of joint
examinationshnsurancereviews varies from region to region. The
regional offices have the option of performing insurance review due
Page 26-8
diligence reviews on a sample of the reports, rather than reviewing

every report.
After completion of the examinatiodinsurance review, the regional

office sends the examination report to the appropriate SSA using either
electronic or regular mail. NCUA’s goal for reviewing the reports of
joint examinations and insurance reviews is an average 30-day
turnaround. Generally, the SSA’s procedures dictate methods for
transmitting the report.
Joint SSAs’ practices vary regarding the holding of joint conferences and
Conferences exit interviews. Some SSAs hold joint conferences on select cases, and
others after their office has reviewed the report. NCUA may meet with
the officials at the conclusion of each joint examinatiodinsurance
review to discuss problems and seek agreements to resolve the
problems. This occurs only after notification and review with the SSA,
who must always have the opportunity to participate and to lead the
meeting.
When the state holds a joint conference, the SSA examiner usually
leads the meeting. NCUA attends and, jointly with the SSA, discusses
all safety and soundness areas, and ensures adoption of appropriate
plans of action. If the officials will not adopt the proposed plan, the
SSA and NCUA obtain agreement that the credit union will develop
alternative plans acceptable to both parties. Generally, the examiners
should avoid duplicating issues unless previously agreed upon as a
method of underscoring the importance of a particular concern to both
the state and NCUA; however, fully airing the concerns of both parties
must remain the overriding consideration.
The SSA examiner in charge should provide credit union management

reasonable opportunity to respond to existing and potential problems
following the joint conference. The SSA examiner in charge instructs
the credit union to respond to all areas of concern raised by both the
SSA and NCUA. Both the SSA and NCUA receive copies of any
written response.
In rare instances, credit union officials do not concur with the

examiner’srecommendations for corrective action, even though a
Page 26-9
EXAMINER’S GUIDE
defined or potential loss exists that requires closer monitoring. The

SSA and NCUA jointly outline a plan for corrective action, which
contains procedures and timeframes for completion. The SSA should
then ask the credit union to respond with their plans for carrying out
the corrective actions, or to develop an alternative plan that will
accomplish the same goals. In any case, the credit union remains
responsible for correcting its safety and soundness weaknesses.
Supervision Supervision is the ongoing monitoring of a credit union’s financial and

of FlSCUs operational condition. As such, supervision involves not only review
of areas of concern and the progress the credit union is making in
correcting those problems, but supervision also looks forward at risk
indicators, which may alert the examiner to emerging areas of risk.
Responsibility for routine monitoring and supervision of FISCUs
primarily rests with the SSA. When an NCUA examiner believes the
credit union needs further supervision or monitoring, the examiner will
discuss it with the SSA to determine what supervision or monitoring, if
any, the credit union needs, and who will perform any supervision
contacts, and when.
NCUA may, after consulting with the SSA, schedule independent

onsite supervision to review the credit union’s progress in
accomplishing the corrective actions. NCUA will discuss with the
SSA, in advance, any meetings scheduled with officials as a result of
this review. The SSA or a representative may attend the meeting, if
they so request.
Prompt The Credit Union Membership Access Act (CUMAA) amendment to

Corrective the FCU Act mandates a system of prompt corrective action (PCA) to
Action restore the net worth of inadequately capitalized federally insured
credit unions, and an alternative system of PCA for new credit unions
that allows a reasonable time to build adequate levels of net worth. As
a credit union’s net worth continues to decline, the actions required of
the credit union to restore its net worth ratio to an acceptable level
become progressively more stringent.
The three main components of PCA include:
Page 26-10
0 A framework combining:
- Mandatory supervisory actions (MSAs) prescribed by Congress
and indexed to five statutory net worth categories, and
- Discretionary supervisory actions (DSAs) developed by NCUA
to enhance PCA when imposed;
0 Alternative PCA requirements for credit unions defined by
CUMAA as new; and
0 Risk-based net worth (RBNW) requirement for applicable credit
unions.
When a FISCU requires prompt corrective action, NCUA will notify

and work cooperatively with the SSA for certain actions including the
following:
0 Lowering a net worth category resulting from a decline in the net

worth ratio;
0 Imposing any DSAs;
0 Approving or disapproving of new, revised, or amended net worth
restoration plans or revised business plans;
0 Placing a FISCU into conservatorship or liquidation; and
0 Approving a reduction in the earnings retention requirement.
The Prompt Corrective Action chapter contains more detailed

information on this subject. Additionally, the written agreements
between the SSA and region may address PCA and FISCUs.
Problem NCUA’s district examiners monitor most problem credit unions and,
Credit Unions along with the SSA examiners, work with the credit unions to resolve
problems. However, NCUA assigns to the regions’ Divisions of
Special Actions some problem credit unions, because of their size,
complexity of problems, or degree of potential risk or loss to the
NCUSIF. NCUA notifies the SSA when it assigns a FISCU to special
actions. The NCUA Special Actions Problem Case Officers (PCOs)
and the SSA attempt to arrange a mutually convenient date to
commencejoint onsite work. If the SSA PCO or examiner is
unavailable, the NCUA PCO should arrange to meet with the SSA
following the contact to review results and recommendations before
meeting with the FISCU officials. The examiners should make efforts
to eliminate multiple contacts and return trips.
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EXAMINER'S GUIDE
NCUA and SSA examiners should work collectively to prepare a joint

supervisory agreement, a Letter of Understanding and Agreement
(LUA). NCUA and SSA examiners should work jointly with FISCUs
to assist them in the development of Net Worth Restoration Plans (if
required by PCA) to address the risks. These agreements should
address insurance risk that threatens the credit union's viability and
presents a significant risk to the NCUSIF. SSA and NCUA staff should
maintain a professional demeanor with each other and the FISCUs at
all times to avoid unnecessary distraction from insurance risks, safety
and soundness issues, or other regulatory problems.
In FISCUs having serious operational or management problems that

normal supervisory efforts have not, or cannot resolve, administrative
actions represent the strongest supervisory tools available to NCUA
and the SSA. The purpose of administrative actions is to prevent, alter,
or eliminate serious operational problems in a credit union. They
firther protect the credit union, its members, its creditors, and the
NCUSIF. NCUA consults with SSAs before taking any administrative
action.
Before placing a FISCU in conservatorship or liquidation, NCUA will

seek the views of the appropriate SSA and will give the SSA an
opportunity to place the credit union in conservatorship or liquidation.
Page 26-12
APPLICATION AND AGREEMENT FOR INSURANCE -
APPENDIX 26A
Application TO: The National Credit Union Administration Board Date
and The Credit Union,

Agreements
Insurance Certificate Number (if applicable)
for Insurance
Of Accounts (Mailing Address) (City) (State)-(Zip Code)
applies for insurance of its accounts as provided in Title I1 of the Federal Credit Union Act, and in
consideration of the granting of insurance, hereby agrees:
1. To permit and pay the cost of such examinations as the NCUA Board deems necessary for the
protection of the interests of the National Credit Union Share Insurance Fund;
2 . To permit the Board to have access to all records and information concerning the affairs of
the credit union, including any information or report related to an examination made by or for
any other regulating authority, and to furnish such records, information, and reports upon
request of the NCUA Board;
3. To possess such fidelity coverage and such coverage against burglary, robbery, and other
losses as is required by Parts 701.20 and 74 1 of NCUA's regulations;
4. To meet, at a minimum, the statutory reserve and full and fair disclosure requirements
imposed on federal credit unions by Section 116 of the Federal Credit Union Act and Parts
702 of NCUA's regulations, and to maintain such special reserves as the NCUA Board may
by regulation or on a case-by-case basis determine are necessary to protect the interests of
members. Any waivers of the statutory reserve or full and fair disclosure requirements or any
direct charges to the statutory reserve other than loss loans must have the prior written
approval of the NCUA Board. In addition, corporate credit unions shall be subject to the
reserve requirements specified in Part 704 of NCUA's regulations;
5. Not to issue or have outstanding any account or security the form of which has not been
approved by the NCUA Board, except accounts authorized by state law for state credit
unions;
6 . To maintain the deposit and pay the insurance premium charges imposed as a condition of
insurance pursuant to Title I1 (Share Insurance) of the Federal Credit Union Act;
7. To comply with the requirements of Title I1 (Share Insurance) of the Federal Credit Union
Act and of regulations prescribed by the NCUA Board pursuant thereto; and
8. For any investments other than loans to members and obligations or securities expressly
authorized in Title I of the Federal Credit Union Act, as amended to establish now and
maintain at the end of each accounting period and prior to payment of any dividend, an
Investment Valuation Reserve Account in an amount at least equal to the net excess of book
value over current market value of the investments. If the market value cannot be determined,
an amount equal to the full book value will be established. When, as of the end of any
dividend period, the amount in the Investment Valuation Reserve exceeds the difference
Page 26A-1
EXAMINER'S GUIDE
between book value and market value, the board of directors may authorize transfer of the
excess to Undivided Earnings.
9. When a state-chartered credit union is permitted by state law to accept nonmember shares or
deposits from sources other than other credit unions and public units, such nonmember
accounts shall be identified as nonmember shares or deposits on any statement or report
required by the NCUA Board for insurance purposes. Immediately after a state-chartered
credit union receives notice from NCUA that its member accounts are federally insured, the
credit union will advise any present nonmember share and deposit holders by letter that their
accounts are not insured by the National Credit Union Share Insurance. Also, future
nonmember share and deposit fund holders will be so advised by letter as they open accounts.
10. In the event a state-chartered credit union chooses to terminate its status as a federally insured
credit union, then it shall meet the requirements imposed by Sections 206(a)( 1) and 206(c) of
the Federal Credit Union Act and Part 74 1.6 of NCUA's regulations.
1 1. In the event a state-chartered credit union chooses to convert from federal insurance to some
other insurance from a corporation authorized and duly licensed to insure member accounts,
then it shall meet the requirements imposed by Sections 206(a)(2), 206(c), 206(d)(2), and
206(d)(3) of the Federal Credit Union Act.
In support of this,application, we submit pages 1-6 and Schedules described below:
Schedule No. Title
Certifications and Resolutions

We, the undersigned, certify that we are duly elected and qualified presiding officer and recording
officer of the credit union and that at a properly called regular or special meeting of its board of
directors, at which a quorum was present, the following resolutions were passed and recorded in
its minutes:
We, the undersigned, certify to the correctness of the information submitted.
Be it resolved that this credit union apply to the National Credit Union Administration Board for
insurance of its accounts as provided in Title I1 of the Federal Credit Union Act.
Be it resolved that the presiding officer and recording officer be authorized and directed to
execute the Application and Agreement for Insurance of Accounts as prescribed by the NCUA
Board and any other papers and documents required in connection therewith and to pay all
expenses and do all such other things necessary or proper to secure and continue in force such
insurance.
We further certify that to the best of our knowledge and belief no existing or proposed officer,
committee member, or employee of this credit union has been convicted of any criminal offense
involving dishonesty or breach of trust, except as noted in attachments to this application. We
further agree to notify the Board if any existing, proposed, or future officer, committee member,
or employee is indicted for such an offense.
(Signature) Presiding Officer, Board of Directors (Print or type Presiding Officer's Name)
(Signature) Recording Officer, Board of Directors (Print or type Recording Officer's Name)
Page 26A-2
Chapter 27
SH0 RTAGES
TABLE OF CONTENTS
SHORTAGES................................................................................................................ ..27. 1
Associated Risks ................................................................................................. .27. 1
Overview............................................................................................................. .27. 1
Examiner's Role ................................................................................................... 27-1
Examination Scope .............................................................................................. 27-2
Notifying Credit Union Officials ......................................................................... 27-2
Notifying Surety................................................................................................... 27-4
Notifying the U S . Department of Treasury (FinCEN) ........................................ 27-5
Establishing Accounts Receivable ...................................................................... .27.5
Contacts with the Press ........................................................................................ 27-6
Unrecorded Shares ............................................................................................... 27-6
Embezzlements ................................................................................................... .27.6
Fictitious and Unauthorized Loans .......................................................... 27-7
Loans to Employees and Family Members .............................................. 27-9
Theft of Member Shares .......................................................................... 27-10
Overdrawn Accounts............................................................................... .27. 11
Theft of Loan ProtectionLife Savings Insurance Claim Proceeds ..........27-11
Theft of Credit DisabilityKredit Life Insurance..................................... .27. 12
Theft of Receipts by Collection Agencies .............................................. .27. 12
Embezzlement through the Credit Union's Expense Ledger .................. 27- 12
Theft of Closed Accounts ........................................................................2 7.12
Deposits in Transit ................................................................................... 27-13
Unapplied Data Processing and Suspense Accounts .............................. .27. 13
Kiting ....................................................................................................... 27-13
Burglary, Robbery, and Larceny .......................................................................... 27-15
False or Fraudulent Statements ........................................................................... .27.15
Mysterious Disappearance .................................................................................. .27. 16
APPENDIX 27A - Warning Signals .............................................................................. . 2 A. 71
Chapter 27
SHORTAGES
Examination 0 Determine whether a shortage exists in the credit union
Objectives Determine whether the credit union has take appropriate action to
identify the shortage, notify surety, and to correct underlying
problems that caused the shortage
Associated 0 Reputation Risk - includes the risk that management did not
Risks establish adequate internal controls to detect or deter shortages,
resulting in poor publicity or administrative action;
Liquidity Risk - includes the risk that adequate liquidity is not
available due to reliance on inaccurate financial reports; and
0 Transaction Risk - includes the risk that financial reports are not
accurate due to manipulation of financial transactions.
Overview A shortage is any loss of funds or property belonging to a federally

insured credit union caused by dishonesty such as embezzlement,
robbery, burglary, kiting, mysterious disappearance, and larceny.
NCUA provides guidance to all federally insured credit unions that

discover a shortage. However, credit union officials must take ultimate
responsibility for providing adequate internal controls, detecting
shortages, and taking appropriate action when they discover shortages.
Examiner’s Examiners should not approach every examination believing a

Role shortage exists or that employees or officials are dishonest. However,
if examiners suspect a shortage, they should determine whether one
exists. Audit procedures are not a normal part of the examination
process and are beyond the scope of this Guide; therefore, examiners
may find it necessary to perform certain audit steps to determine
whether shortages are occurring.
Credit union officials, the regional office, the examination process, or

some other source may alert examiners to a possible shortage. The
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EXAMINER'S GUIDE
procedures described in this and other chapters will assist the examiner
in determining whether a shortage exists, the.extent of the shortage,
and the necessity of further action, such as an audit. Follow-up on
shortages is part of district management.
Examiners should be cautious about what they say regarding possible

shortages. Before confronting an individual suspected of a shortage,
informing credit union officials of a suspected shortage, or taking any
action regarding the removal or suspension of any employee or official,
the examiner should contact the supervisory examiner. Upon
discovering a shortage, the examiner should suggest that officials mail
the Suspicious Activities Report (SAR) to the U.S. Department of the
Treasury's Financial Crimes Enforcement Network (FinCEN), and
notify surety. Many types of shortages also require the officials to
notify the local police authority and the Federal Bureau of
Investigation (FBI).
Examination If the examiner discovers or learns of an internal shortage, the

Scope examiner should expand the examination as necessary to determine the
facts surrounding the alleged embezzlement. After discovering and
documenting the pattern, the supervisory committee must investigate
and resolve the shortage.
The examiner should document in the report any material shortage and
actions taken by management to resolve the shortage.
Notifying As soon as examiners determine with reasonable certainty that a

Credit Union shortage exists, they should discuss the matter with the supervisory
Officials examiner. After concurrence from the supervisory examiner, the
examiner should contact the board chairperson and arrange for a board
meeting. The directors should invite members of the supervisory and
credit committees. The examiner should consider inviting the
supervisory examiner or another available examiner to attend and
witness this meeting. At that meeting:
The examiner should present directors with evidence that indicates

the shortage. The board may give the person allegedly responsible
the opportunity to be heard.
Page 27-2
SHORTAGES
0 The examiner should discuss the surety bond provisions, the filing
of a bond claim, and should encourage the officials to contact
surety in a timely manner.
If proven, the board should suspend or terminate the official or

employee responsible for the embezzlement. Ultimately, it is the
board's responsibility to take appropriate action. The examiner's
goal is to ensure that the person responsible no longer has the
ability to cause losses or destroy credit union records. However,
examiners should not act before contacting the supervisory
examiner for concurrence.
The officials usually will suspend or terminate an alleged

embezzler during the meeting, and should contact surety in a
timely manner. The person responsible may volunteer to resign
before the board meeting.
0 If an embezzler makes fidl restitution, the directors might fail to

take action against the alleged embezzler. The examiner should
explain the board's fiduciary responsibility to the members and
point out that failure to act may result in release of surety from
liability for any future shortages. In addition, the directors may be
personally liable for losses sustained because of their failure to act.
0 The examiner should make certain that the officials clearly

understand their responsibilities to update records and to perform
(or cause to be performed) an audit. In some cases, they should
explore using a qualified fraud audit firm.
0 Under most surety bond policies, credit unions have an obligation

to mitigate damages by taking reasonable steps to reduce their loss.
If the perpetrator offers restitution, officials should contact legal
counsel and surety for an opinion and concurrence before
acceptance. Officials should be skeptical of accepting any
restitution other than cash. If the perpetrator offers a check, the
officials may accept it subject to collection. Any receipt given
should only acknowledge the amount and manner of payment and
should not allege to be "payment in fill.'' If the directors accept
restitution, the minutes should document the acceptance. If the
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EXAMINER’S GUIDE
question arises, the examiner should encourage the directors not to

change the credit union’s surety during presentation of the claim.
The examiner should caution the officials against agreeing, in

writing or orally, not to prosecute the responsible person in
consideration of repayment or promise of repayment. The officials
should not release the credit union’s claim against the responsible
person without legal counsel’s advice.
The examiner should inform the directors about the harm that
publicity regarding a shortage often does to a credit union and
advise them to avoid it if possible. Conversely, rumors sometimes
do more harm to member confidence than the actual facts. When
information about a shortage becomes publicly known, the
directors may call a special meeting of the members and present
the facts concerning the shortage. In most instances, however, such
a meeting is not necessary or desirable.
Other matters the examiner should consider discussing with the

board include (1) reviewing the alleged embezzler’s loan and share
accounts, (2) changing combinations or locks, (3) changing access
and passwords to all electronic systems, (4)changing signatures at
banks or other institutions, (5) revoking investment redemption
authority, (6) stopping payment on checks that contain known
forgeries, and (7) pinpointing the responsibility of the person
designated to maintain the records.
Notifying It is the officials’ responsibility to send notice of loss to surety. If the

Surety credit union officials refuse to notify surety, the examiner should
discuss the refusal with the supervisory examiner. The examiner
should inform the credit union officials that their failure to file a notice
of loss could result in loss of the bond claim and, therefore, breach
their fiduciary duties. The credit union should request Proof of Loss
forms from the surety bond company.
The exact amount of the shortage need not be known before giving
notice of loss to surety. (A delay until the officials know the specific
amount could jeopardize recovery of the claim from the surety
company.) The examiner should review pertinent provisions of the
Page 27-4
SHORTAGES
surety bond and refer to the Bond Coverage section of this Guide
before advising officials or sending the notice of loss to surety.
The surety bonds currently in use in credit unions differ in respect to

the notice of loss provisions, so it is very important to review the credit
union's surety bond. Officials must provide notice to surety within a
specified number of days of discovery (as specified in the bond
notification requirements.) When the claim is significant in relation to
credit union reserves, credit unions should consider seeking legal
assistance from an attorney familiar with surety bond law.
Examiners should review prior bonds in effect during the period of the
shortage to determine if the officials should provide notice to more
than one surety company. If credit union files do not contain complete
copies of the bonds, officials should contact surety bond companies
and request a copy.
Once the auditor has completed the audit and verification, officials
should submit a proof of claim to surety within the time limits
specified. Please refer to the Bond Coverage chapter for additional
guidance.
Notifying the The FBI investigates and the local US Attorney prosecutes cases
U.S. involving violations of federal criminal statutes. As set forth in 9748.1
Department of the NCUA Rules and Regulations, the officials must complete the
of Treasury SAR and mail the report to FinCEN.
(FinCEN)
In cases of criminal activity, the officials noti& the FinCEN by
completing and submitting a SAR, which includes the instruction for
completion. (If the officials indicate reluctance to completing the form,
the examiner should discuss with the supervisory examiner whether or
not the examiner should notify FinCEN.)
Establishing The credit union may establish an account receivable in accordance

Accounts with generally accepted accounting principles, taking care not to
ReceivabIe unreasonably anticipate a recovery. If properly established, the account
remains on the credit union's records until surety pays the claim, or
recovery is a reasonable certainty.
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EXAMINER'S GUIDE
Contacts with After learning of a possible shortage, the press may contact the credit
the Press union or examiner for information. Examiners should point out to
reporters that they may not release any information and that the credit
union's officials are the proper source of information. In rare instances,
the examiner may refer a persistent reporter to the regional office.
Where significant shortages exist or when obvious criminal activity
occurs, the credit union should develop a plan for dealing with the
press that includes appointing a single credit union spokesman.
Unrecorded The potential exists for unrecorded shares in a credit union, which can
Shares cause losses to the National Credit Union Share Insurance Fund
(NCUSIF.) The following steps may assist in revealing unrecorded
shares:
0 Review adequacy of verification of member accounts;

0 Review internal controls over printing and mailing of statements;
0 Review supervisory override reports for management overrides of
cash transactions;
0 Review volume of transactions in credit union's checking account.
A high volume of transactions during the month may warrant
further review; and
0 Review supervisory committee's or head teller's role in performing
surprise cash accounts.
Embezzle- The term embezzlement, defined as acts by officials or employees for

ments the purpose of diverting f h d s for their own or a third party's benefit,
includes ail internal shortages. Appendix 27A contains a list of
"Warning Signals" that might indicate a shortage.
Some of the most common embezzlements include:
0 Fictitious or unauthorized loans;
0 Unreported loans to employees and family members;
0 Unrecorded shares;
Page 27-6
SHORTAGES
Theft of member shares (especially dormant or inactive accounts);
Overdrawn accounts;
Theft of insurance proceeds;
Theft of receipts by collection agencies;
Theft through unauthorized expenses;
Misappropriation of travelers checks or money orders;
Theft of closed accounts;
Misappropriation of loans from other credit unions;
Misappropriation of credit union checks;
Misappropriation of deposits in transit;
Misappropriation by manipulating payroll deductions;
Misappropriation through the information processing system;
Misappropriation of credit union investments;
Computer crime;
Repossessed collateral; and
Non-payroll deduction transfers to credit union employee accounts.
Fictitious and A fictitious loan exists when the credit union disburses funds to an
Unauthorized account in the pretense of granting a loan, but no actual loan was
Loans made. Unauthorized loans are loans made in the name of real members
without their knowledge or consent. General characteristics are:
The embezzler creates some or all the documentation creating the

loan, forging signatures as necessary.
Page 27-7
EXAMINER'S GUIDE
The address used for mailing member statements and account

verifications is under the control of the embezzler (a post office
box, the embezzler's home address, or the credit union's own
address). The AIRES loan and share download allows examiners to
perform various share queries for determining if possible shortages
exist. Sometimes the embezzler simply destroys the statements
before they leave the credit union.
The embezzler usually uses a direct payment method (i.e., cash

payment) rather than payroll deduction.
Methods of detecting unauthorized or fictitious loans include:
Reviewing loan documentation for discrepancies in the documents,

such as validity of dates, legitimacy of signatures, or evidence of
tampering;
Verifying the borrower's name and address from non-credit union

documents, such as telephone books, city address directories, credit
reports, and certificates of title, sponsor records, or directory
assistance;
Comparing the address in the loan file with the address in the
credit union's computer records;
Comparing the address listed in the loan documentation against the

addresses of credit union officials or employees;
Comparing the signatures on loan documents, including signatures

approving the loans, with the credit committee members' signatures
or those of any other employees authorized to approve loans;
Comparing the member's signature on the note with the signature

on the membership card; and
Verifying by telephone the accuracy of loan information with the

purported borrower.
In most credit unions, examiners find it impossible to review all loan

files for evidence of unauthorized or fictitious loans, and a random
Page 27-8
SHORTAGES
sample of loans may not uncover such a scheme. The following red
flags may indicate that there is a cause to examine certain loans:
0 "Next payment due date" more than 60 days in the future;
0 Loans not reported as delinquent, but the records indicate interest

due;
0 Repayment of principal not current, but records indicate no interest

due;
0 The original and the current loan balance approximately the same
when the payment schedule indicates that the current balance
should be significantly less;
0 Unusual loan payment, interest rate, or balance or one that differs

significantly fiom the typical credit union loan ( i.e., zero interest
rate loans);
0 No payment for 90 days but loan not listed as delinquent;
0 Memberk share balance less than the current loan balance on a

share secured loan; and
0 Collateralized loan, but no outside third party documentation in the

files confirming the existence of the collateral or the credit union's
lien. (Credit union-generated documents and other form letters are
not acceptable documentation.)
Loans to Another type of internal shortage is a fraudulent loan in the name of

Employees and the embezzler or the embezzler's family members. Generally, the
Family perpetuator has not followed loan policies and procedures and ignores
Members repayment and collateralization criteria.
Procedures that might assist the examiner in uncovering fraudulent

loans include:
Reviewing loan policies that relate to loans to employees, officials,

and their family members;
Page 27-9
EXAMINER'S GUIDE
0 Reviewing loans to current employees and officials for current

payments, valid approval signatures, and adequate share balances
for share secured loans.
Theft of The following steps detail how theft of member shares can occur. First,
Member Shares the embezzler drafts a withdrawal check payable to the member, forges
the endorsement, and cashes the check. Second, the embezzler
completes a cash withdrawal voucher, which the credit union posts to
the member's account. Finally, the credit union transfers funds from
the member's account to an account under the embezzler's control. This
type of embezzlement generally occurs in relatively inactive accounts
(no loans) and conceals the embezzlement by diverting the member's
statement before it leaves the credit union, altering it, or preparing a
new statement.
To verify theft of member's shares, the examiner should:
Scan accounts with relatively large balances, no loans, and

significant withdrawals or transfers. For withdrawals, verifjr the
signature on the check with those on the membership card. If the
signature is questionable, pull other documents signed by the
member to test authenticity. If the signature is still doubtful,
consider first whether the signature may be by a party with
authorization to sign, for example those with a power of attorney;
0 Compare records of inactive accounts from a year ago with current

inactive accounts. Then check the member statements for those
member accounts that do not appear on the most recent inactive
list;
0 Review the other account if a withdrawal is by transfer to another

account. Generally these transfers go to another account of the
member or the account of a family member; and
0 Contact the member directly or by telephone to determine the

legitimacy of the withdrawals.
Page 27-10
SHORTAGES
Overdrawn A relatively simple method for creating a shortage is to overdraw a

Accounts share or share draft account with no intention of repaying the
overdrawn amount. Indicators of this type of embezzlement include
negative balances in accounts, nonassessment of nonsufficient h d s
(NSF) fees or reversal of such fees, posting of drafts out of sequence,
manual clearing of checks, and frequent appearance of insider names
on the NSF check listing. Examiners should analyze the negative share
and share draft report during the examination at various cut-off dates
rather than just at month-end to uncover overdrawn amounts that credit
union staff may have "fixed" at month end. The accounts most likely
to contain unresolved amounts include those of credit union
management, accounting department personnel, and family members
of these individuals.
Theft of Loan Theft of loan protectiodlife saving insurance claim proceeds takes
ProtectiodLife several forms:
Savings
Insurance Claim 0 The embezzler increases the share or loan balances of a deceased
Proceeds member and steals the insurance proceeds once the credit union
files and receives a claim;
0 If the embezzler believes the beneficiary is unaware of the

insurance, he steals the credit union check for the insurance
proceeds, forges the endorsement, and cashes the check in the
credit union; or
0 The embezzler creates a fictitious account for a deceased

nonmember, files a claim with the carrier, and keeps the proceeds
check for his own use.
When the examiners suspect this type of shortage, they may obtain
confirmation by requesting from the insurance carrier a copy of the
claims register for the credit union. They compare this register to the
credit union's records. Through spot-checking, they contact the
beneficiaries to verify disbursements indicated in the credit union's
records.
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EXAMINER'S GUIDE
Theft of Credit Misappropriating credit life or credit disability claim checks, refunds,
DisabilityICredit or dividends constitutes theft. Although the member pays premiums
Life Insurance for this insurance, the insurance company makes dividends and refund
checks payable to the credit union and sends them directly to the credit
union. The procedure for detecting this form of shortage involves
requesting the appropriate registers from the insurance company,
tracing the proceeds through the credit union's records, and verifying
with beneficiaries the actual receipt of the funds.
Theft of This shortage involves misappropriation of credit union receipts from

Receipts by collectors of delinquent or charged-off loans by either credit union
Collection employees after remittance to the credit union or by the collectors
Agencies themselves. To confirm these shortages, the examiner should secure a
register of all collection loans from the collector and compare the
balances with the credit union's records for discrepancies. To
determine whether collectors are misappropriating fimds, the examiner
should contact the member directly to verify that the credit union
applies all payments to the loan balance.
Embezzlement Embezzlement through the expense ledger usually occurs through

through the overpayment of salaries, payment of personal bills or other personal
Credit Union's expenses. Comparing credit union salaries, confirmed through board
Expense Ledger minutes or other documentation, with amounts paid per the expense
ledger can detect this embezzlement. The examiner should check
disbursements for proper invoices in the credit union's name.
Theft of Closed In another common form of embezzlement, the embezzler steals an

Accounts entire account balance and closes out the account. The embezzler
usually targets retired or out-of-town members with no outstanding
loans or account activity. The embezzler either forges the endorsement
on the share withdrawal check or transfers the money from the
member's account to an account under the embezzler's control.
To document theft of closed accounts, the examiner should obtain a

list of recently closed accounts, examine the final member statement
for unusual transactions, compare the signatures on the final
withdrawal check with those on the membership card, and, if
Page 27-12
SHORTAGES
necessary, verifl the closing of the account directly with the member.
For accounts closed by share transfer, the examiner should review the
account of the transferee and, if necessary, confirm the transfer with
the original member.
Deposits in The embezzler can conceal a shortage by increasing deposits in transit

Transit to cover the amount stolen. A detailed examination of bank
reconciliations can confirm this shortage. Embezzlers can also use
deposits in transit to conceal kiting (discussed later in this chapter.)
Unapplied Data Inflating the unapplied data processing suspense accounts by

Processing and individuals with responsibility for reconciling or correcting these
Suspense accounts can also conceal a shortage. These accounts show the amount
Accounts of unprocessed transactions rejected by the information processing
system, often due to timing differences. The examiner should
determine whether the amount in the unapplied data processing
suspense account appears large relative to the size and operation of the
credit union. Moreover, examiners should ensure that they can identify
individual items in the account and that these items clear in a timely
manner.
Kiting Kiting is depositing a check from an account with non-sufficient funds

to cover a withdrawal of funds from another account with non-
sufficient funds. Kiting may involve one or more persons and can be
internal or external. It usually involves credit union employees,
because they have access to the records daily and are familiar with
policies and procedures. The credit union should design internal
controls to prevent kiting. Types of kiting are:
0 Internal kiting - usually involves credit union employees. The most

common forms of employees kiting are:
- Two share draft accounts - continually writing drafts between

the two accounts without sufficient funds to cover all drafts
written.
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EXAMINER'S GUIDE
- Regular share and share draft accounts - continuous transfer of

funds between the two accounts without sufficient funds to
cover all transactions.
- Share draft and Line of Credit - writing share drafts to pay

amount due on a line of credit without sufficient f h d s in the
draft account and then accessing the line of credit to pay share
draft overdrafts.
- Share draft - delay in processing transactions to prevent an

overdraft.
- ATM - delay in processing transactions to prevent a negative

balance.
- Share account - negative balance without fees or interest being

charged.
Employee kiting - reviewing employees' account statements or

transaction history for the most recent two to three months will
usually detect employees' kiting. If the statements contain
numerous transactions in a short time, the examiner should make a
more in-depth investigation.
0 External kiting - pertains to members' accounts. External kiting

schemes usually involve the credit union and one or two other
financial institutions. A member writes share drafts or checks
against one or both of the other financial institutions. The member
has insufficient funds in that institution to cover the check. Credit
union employees should analyze any account that indicates large
check deposits and equally large cash withdrawals within a short
time. If they uncover a kiting scheme, management should not
release large cash withdrawals before receiving the actual funds
from the deposits made. Telephone verification will not catch
external kiting as the member may immediately withdraw funds
from the institution on which the check was written.
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SHORTAGES
Burglary, Except when the loss presents a material risk to the credit union and to
Robbery, and the NCUSIF, an examiner normally need not make a contact when
Larceny learning of a burglary, robbery, or larceny. If examiners decide to make
an on-site contact, they should contact their supervisory examiners.
The examiner will determine that the officials have:
Notified surety and made necessary claims; and
0 Mailed the SAR to the FinCEN (if applicable).
During the examination or supervision contact following the burglary,

robbery or larceny, the examiner should detail pertinent information
about the incident in the report.
False or $1014 of Title 18 of the United States Code makes it a federal crime
Fraudulent for anyone to knowingly make a false statement or report, or to
Statements willfully overvalue any land, property, or security, for the purpose of
influencing in any way the action of a federal credit union on any
application, advance, discount, purchase, purchase agreement,
repurchase agreement, commitment, or loan or any change or
extension of any of the same, by renewal, deferment of action or
otherwise, or the acceptance, release or substitution of security
therefore.
Among the most common acts coming under $ 1014 are forging of co-
maker's signature on the note, making false statements as to ownership
or value of property offered as security for a loan, and false statements
as to the purpose of a loan. The officials should obtain as much
evidence as possible to support a potential bond claim. A sworn
affidavit from the person whose name was used is usually sufficient.
The credit union officials should use caution when they discover an
instrument containing an apparent forgery of the name of a relative.
Frequently, these persons will claim that they gave permission for use
of their names. Consequently, proving the loss is difficult since the
credit union could not proceed against the person.
The examiner should use extreme care in dealing with possible

violations of $ 1014 of the US Code. Incorrect statements about
Page 27-15
EXAMINER'S GUIDE
ownership or value of property or about the purpose of a loan may not

necessarily represent a violation under 5 1014 unless the person making
such statements knowingly makes them with willful intent to mislead
the credit union. The examiner should contact the supervisory
examiner if any doubt exists about an alleged violation.
When a violation occurs, the examiner should determine that the credit
union has notified surety and filed a SAR with the FinCEN (if
applicable). If the board of directors declines to report a violation to
surety and the FinCEN, the examiner should ask the supervisory
examiner about the process of reporting a violation.
Mysterious Losses may occur in federal credit unions through the mysterious,
Disappear- unexplainable disappearance or misplacement of property. Credit
ance union blanket bonds often cover the losses either as a standard feature
or as a rider to the bond. If the credit union discovers a mysterious
disappearance, it should review the bond to determine if surety covers
the loss. On rare occasions, examiners may encounter credit unions
that use mysterious disappearance rather than to name a person
responsible for embezzlement in order to avoid confronting or taking
action against that individual or to hide the real cause for a loss.
The surety and the FinCEN should be notified only when the
circumstances of the mysterious disappearance lead officials to
conclude that a criminal act occurred.
Federal credit unions' bonds do not cover tellers' overages and

shortages. Management should avoid nuisance claims and must clearly
identify the loss of the funds. For example, if the cash is short $100 at
the end of the day, this is a teller's shortage and therefore not a
claimable item. On the other hand, a mysterious disappearance occurs
if member John Doe gave the treasurer $100 that the treasurer placed
in a desk drawer and later cannot locate.
and - Supplementary Facts
References - Suspicious Activity Report
Page 27-16
WARNING SIGNALS = APPENDIX 27A
Warning Attempts on the part of the treasurer, the manager, or an employee
Signals to postpone or delay the examination or the supervisory committee's
audit.
General conditions of books and records are unfavorable. Records

not posted currently or out of balance for long periods of time.
Failure of personnel to produce records for which they are

responsible, or attempts on their part to delay access to records or cash
on hand.
Extreme nervousness or evasiveness in answering questions by

personnel during examinations and audits.
Failure of key personnel to share work or records with other

employees. Attempts on the part of promoted employees to retain
control of certain records because they "knowthe work."
Failure of personnel to take vacations or attempts of personnel to

retain control over records during vacation.
Excessive personal spending habits of employees relative to the

standard of living possible on their visible income, often indicated by
heavy drinking, gambling, big cars, or expensive parties.
Personal checks or IOUs used to balance petty cash or change

funds.
0 Inadequate bank records. No provision made for the reconcilement

of cash received with bank deposits. Failure to deposit all collections
intact so that they can be identified.
No receipts for cash transfers between the credit union office and
field collectors or between employees in the credit union office.
Cash overages and shortages not recorded.
Page 27A-1
EXAMINER'S GUIDE
Missing notes, ledger cards, or records of past transactions,

particularly canceled checks and member share and loan ledger cards.
0 Unusual and rapid increases in delinquent loans, without apparent

accompanying causes such as strikes or layoffs, or long-term
delinquencies for which there is not a satisfactory explanation.
Unexplainable decreases in assets and in member share account

balances at a time when the credit union should be growing.
Credit union expenses unreasonably out of proportion with gross

income.
Loans to credit union officials, members of their families, or

employees in excessive amounts.
Inadequate information on loan papers of credit union officials,

members of their immediate families, and employees. Excessive
delinquency on these loans.
High percentage of no-response accounts during positive account

verifications mailed to the members' homes. Over a period of time, a
pattern appears involving the same no-response accounts.
0 Verification letters returned to the credit union office instead of to

the supervisory committee. Lack of control by the supervisory
committee.
Failure of the board of directors to establish necessary and

adequate control over operations.
Failure of the supervisory committee to perform comprehensive

audits as required by law.
Page 27A-2
Chapter 28
BOND COVERAGE
TABLE OF CONTENTS
BOND COVERAGE ....................................................................................................... 28-1

Overview............................................................................................................ ..28.1
Fidelity Bond Review ........................................................................................ ..2 8.2
Background, Requirements and Approved Bond Forms ................................... ..28.2
Endorsements and Riders ..................................................................................... 28-3
Faithfbl Performance Coverage .......................................................................... .28-3
Principles and Obligations for Fidelity Losses .................................................. ..28-3
Insurance Losses ..................................................................................................2 8-4
Covered Losses .................................................................................................... 28-5
Claims Under Bond .............................................................................................. 28-5
Acts That May Terminate Bond Coverage - Letter of Notification .........28-6
Notice and Proof of Loss ......................................................................... 28-7
Bond Claim Follow-up ........................................................................................ 28-7
Chapter 28
BOND COVERAGE
Examination 0 Determine if the credit union has adequate bond coverage to
Objectives comply with Part 7 13 of the NCUA Rules and Regulations
Determine if bond claims were filed when appropriate
Associated 0 Compliance risk - Includes the risk that the bond coverage
Risks does not comply with the Federal Credit Union Act and NCUA
Rules and Regulations; and
0 Reputation risk - Includes the risk that bond coverage does not
adequately cover losses resulting from employee or director
fraud, dishonesty, theft or other similar activities, resulting in
poor publicity or administrative action.
Overview The Federal Credit Union Act 0112, 0 1 13(2), and 0 120(h) set forth the
statutory requirements for the bonding of credit union employees and
appointed and elected officials. 3 120(h) requires that the NCUA Board
approve bond forms and prescribe minimum bond coverage. The Act
directs the NCUA Board to promulgate regulations setting forth both
the amount and character of bond requirements for employees and
officials. It also grants the NCUA Board the power to approve bond
forms and to set minimum requirements for bond coverage.
Part 713 of the NCUA Rules and Regulations contains the NCUA
Board's bond regulation, which is made applicable to state-chartered
natural person credit unions by §741.201(a). Part 713 prescribes the
form and the minimum schedule of bond coverage for natural person
credit unions.
This chapter discusses the bonds used by credit unions, known as

"fidelity" bonds, "blanket" bonds, "surety" bonds, or "discovery"
bonds. Whatever the terminology, the bonds all provide the same type
of coverage: primarily coverage against losses caused by fraud,
dishonesty, theft, and other similar activities. The bond may provide
Page 28-1
EXAMINER'S GUIDE
coverage for lack of faithful performance, but neither statute nor

regulation requires that coverage.
Fidelity Bond During the course of an examination, the examiner may (1) determine
Review that the fidelity bond is in force in an amount at least equal to
regulatory minimums; (2) document in the examination workpapers
the bond type, bonding company name, amount of coverage, and any
deductibles, riders, and other clauses; and (3) be alert to any
unprotected areas of risk for the credit union.
Some writers of credit union fidelity bonds have a risk management

division whose auditors will, upon request, perform a risk management
audit designed to detect internal control weaknesses.
At times, examiners may determine that criminal activity or a bondable

loss has occurred which may affect the bondability of an employee or
an official. The examiner should provide details to the board of
directors and obtain an agreement for immediate action. The board is
responsible for notifling the bond company, federal and local
authorities, the SSA, as appropriate, and the regional office. A credit
union must complete a Suspicious Activity Report (SAR) whenever it
reasonably suspects criminal activity. Examiners should determine that
the credit union has filed a SAR within the required time, when
necessary. If the board has not, or will not, complete the SAR the
examiner should complete the SAR, file it in accordance with SAR
instructions, and notifl the regional office and SSA, as appropriate.
Background, All credit unions must provide fraud and dishonesty coverage for
Requirements employees and officials. NCUA mandates that each federal credit
and Approved union board provide adequate coverage. The NCUA Board has the
Bond Forms authority to require that a federal credit union obtain additional
coverage when the coverage in force is not adequate (5713.7.)
Adequate bond coverage may require coverage in excess of the
prescribed minimums. The directors should review the extent of
coverage at least annually (57 13.2.) They should consider the credit
union's loss exposure, internal controls, and financial resources when
determining the amount and the type of coverage necessary. This
determination is particularly critical since the credit union will need to
Page 28-2
BOND COVERAGE
decide whether to purchase optional faithful performance coverage, if

available.
The e-library and at www.ncua.g;ov under the Reference Information

section, Credit Union Bonds, contain the list of currently approved
bond forms for federal credit unions.
Undoubtedly, NCUA will approve additional bond forms in the future.

The regional office has copies of each approved bond form. Examiners
should check with the regional office if they have concerns about a
form.
Endorse- Bond companies issue endorsements or riders to the bond that add to,
ments and or delete from, the basic bond coverage. Examiners should carefully
Riders review any endorsements or riders that exclude coverage and
determine if the endorsement or the rider reduces coverage below the
minimum coverage in the approved bond form. If examiners cannot
determine the effect of the endorsement or rider, they should contact
their supervisory examiner and, if necessary, send a copy to the
regional office with an accompanying memorandum. Riders that
reduce coverage provided by the basic bond must have the approval of
the NCUA Board. Riders that add coverage under the bond do not
need NCUA Board approval.
FaithfuI The credit union’s board of directors make a business decision

Performance regarding whether to purchase faithful performance coverage, although
Coverage state law or regulation may require state-chartered, federally insured
credit unions to maintain such coverage. The contract between the
credit union and the bonding company determines the definition of the
term “faithful performance.” Not every company will sell faithful
performance coverage.
Principles While a fidelity bond represents a contract between the credit union
and and an insurance company, the act of a third party (employee or
Obligations official) invokes the duties under the contract. The three party nature
for Fidelity of the contract distinguishes it from other insurance contracts. (See the
Losses section on Insurance Losses for further discussion.)
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EXAMINER'S GUIDE
The credit union should comply strictly with the terms of the bond to
recover from the bond company. The time limits for filing a notice of
loss, proof of loss, or filing of a lawsuit against the company should
strictly adhere to those specified in the contract, unless the company
waives these time limits in writing. If not, the credit union's rights may
be prejudiced. Bonding companies measure most of the time limits
from the date of discovery of either a wrongful act or a loss.
"Discovery" usually means specific knowledge, but more than mere
suspicion, by a responsible person (manager, official, board member.)
A credit union owes a duty of good faith to the bond company. This
includes disclosure to the bond company of acts of employees, of
which it has knowledge, which increase the bond company's risk.
Since the question of whether a reportable loss has occurred will often
arise during an examination or supervision contact, the directors will
frequently ask the examiner to help them arrive at a decision as to
reporting or giving notice of loss to the bond company, to the recovery
of the funds, or to the filing of a claim.
The board of directors must ultimately make decisions regarding these

factors. The examiner may guide the directors in protecting the credit
union's interests under the bond. The bonding company could hold
directors personally liable for losses suffered by the credit union when
they fail to file a claim in accordance with the requirements of the
bond. If the directors disagree with the examiner that they should
report an act, that a loss occurred, or that they should give a notice of
loss to the bond company, the examiner should follow the guidance
provided in the Shortages chapter of this Guide.
Insurance Bonds authorized for use by credit unions also may contain insurance
Losses coverage for direct loss of property. This coverage protects the credit
union against the direct loss of property caused by such things as
larceny, burglary, robbery, mysterious disappearance, outside forgery,
and the damage or destruction of property due to these incidents. These
examples are not all inclusive, and each bond does not include all of
them. Under these insurance clauses, the bonding company does not
require the credit union to determine the identity of wrongdoers to
recover losses, as it must do to recover for a loss of property caused by
acts of its employees. However, the credit union should file insurance
Page 28-4
BOND COVERAGE
type claims in a manner similar to claims for fraud or dishonesty (i.e.,

by filing a notice of loss followed by a proof of loss within the time
frames called for by the policy.)
Covered The approved bonds cover only direct losses of property. For example,
Losses if an employee steals $10,000 by creating a fictitious loan, the $10,000
is a direct loss of property, which the bond covers. However, the bond
does not cover the interest income that the credit union might have
earned on this $10,000.
For this same reason, the bond usually does not cover expenses of
recovery such as legal fees, although the bond or a purchased
endorsement to the bond often separately provides for audit expenses.
The examiner may review the audit expense coverage, if purchased, for
adequacy to protect the credit union from the unexpected expense of
documenting a claim by outside auditors. The minimal audit expense
coverage often seen in credit union bonds probably will not cover the
costs of a proof of loss audit. Examiners may find it appropriate to
suggest that the board of directors consider a higher audit expense
limit.
Claims Under The credit union needs to inform the bond company of the facts in all
the Bond cases where fraudulent or dishonest conduct occurred, or, if it has
purchased faithful performance coverage, in all cases which might
meet the definition of faithful performance contained in the bond.
Examiners should use caution in developing the facts and in making
recommendations to the directors. Good judgment in making decisions
in this respect is essential.
It is important to distinguish between the reporting of fraudulent or

dishonest acts and the filing of a claim. The credit union need only file
a bond claim when it has suffered a loss. For example, if a credit union
has faithful performance coverage, and the manager knowingly makes
several mortgage loans without getting appraisals, checking titles, or
making credit checks, this might constitute a lack of faithful
performance. Nevertheless, if the borrowers make the contracted
payments on the loans, then the credit union has not yet suffered a loss
and cannot file a bond claim.
Page 28-5
EXAMINER'S GUIDE
The credit union should report fraudulent or dishonest acts, or conduct

amounting to a lack of faithful performance (if the credit union has
such coverage), whether or not the credit union has suffered a loss. If a
loss has not yet occurred, the credit union should inform the fidelity
company that it will file a bond claim at the appropriate time.
Subsequently, when the loss occurs, the credit union should file a
notice of loss, although it need not wait until it knows the exact
amount of the loss.
Officials should always examine the bond itself to determine the scope
of coverage. If examiners have questions about the coverage the bond
provides, they should contact their supervisory examiner.
Nevertheless, whether or not a particular set of circumstances
represents a claim under a particular bond, the officials should notify
the fidelity company of all fraudulent or dishonest acts, or acts
indicating a lack of faithful performance (if the credit union has such
coverage) to ensure continued coverage for the employee involved and
to protect the credit union in the event a loss occurs.
Acts That May The credit union should report only facts to the bond company in a
Terminate Bond notice of improper acts by an employee or any other communication to
Coverage - the insurer. The credit union should not engage in speculation about
Letter of how a loss or potential loss occurred. The following items can be
Notification included in the letter of notification (the bond itself contains specific
requirements) :
Description of the act;

Name and position of persons whose acts may have terminated
bond coverage as it applies to them;
If possible, specific law, bylaw, rule, regulation, policy, or standard
of conduct violated;
An explanation of the acts, which indicates whether they were
fraudulent, dishonest, or unfaithfully performed;
Action taken to correct the acts;
Action taken to prevent recurrence of the acts; and
Request to bond company for a statement of its willingness to
continue bond coverage on persons whose acts are in question.
Page 28-6
BOND COVERAGE
The examiner should encourage the credit union to specifically

mention the names of all responsible persons in the letter when it can
clearly determine responsibility. The examiner may assist the officials
in drafting the letter, but should bear in mind that the credit union, not
the examiner, writes the letter. In the event the credit union refuses to
notify the insurer, then the examiner should follow the guidance
contained in the Shortages chapter.
Notice and The notice of loss is usually very short, factual, and contains no
Proof of Loss speculation or guesses. Credit unions need not know the exact amount
of the loss before giving the notice. In fact, a delay until determination
of the exact amount could jeopardize collection of the claim.
The following are items that the credit union should include in the
notice of loss (refer to the bond for specific requirements):
Statement specifying discovery of a loss;

Date of discovery of the loss;
The amount of the known loss at the time of the notice;
A brief statement of the circumstances surrounding the loss;
Name, position, and address of the person responsible for the loss;
Information as to whether the responsible person was removed
from office;
Request for acknowledgment of the notice of loss; and
The SAR, if filed, should not be included as an attachment to the
notice.
The notice of loss puts the fidelity company on notice that a loss has
occurred and that a claim may follow. Each bond requires filing of a
proof of loss or claim within a specified period of time after the notice
of loss. The proof of loss will usually require a more detailed and
documented explanation of the loss suffered, the acts causing the loss,
and why the credit union believes the bond covers the loss. As with the
notice of loss, the credit union should refer to the policy to determine
the specific requirements for the proof of loss.
Bond Claim Bonds generally specify that the bond company has a certain number
FOIIOW-UP of days after a credit union files a proof of loss to investigate the loss.
Page 28-7
EXAMINER'S GUIDE
Unless the directors receive payment within a short time thereafter,

they should follow up and request prompt settlement. If the bond
company denies a claim, it should do so promptly and advise the credit
union of the reasons for the denial.
Examiners should keep in close contact with any credit union in their
district that has filed a claim with the bond company. If the bond
company delays paying a valid proven claim, the examiner should urge
the directors to follow up promptly.
Since most bonds require the credit union to bring a lawsuit against the
bond company within a specified time after discovery of the loss, the
examiner may wish to recommend that the credit union engage legal
counsel to help it in negotiating payment of the claim or to determine
the advisability of filing suit to collect on the claim. If the credit union
appears to be making progress in negotiating and settling the suit, but
may not meet the deadline for filing suit, the credit union may wish to
secure an extension of the time for filing suit from the bond company.
Workpapers References
and - Federal Credit Union Act
References 120(h) - Powers of the Board and Administration
7 13 - Fidelity Bond and Insurance Coverage for
Federal Credit Unions
NCUA Letter No. 96-CU-3, Suspicious Activity Report
NCUA Letter No. 00-CU-04, Suspicious Activity Reporting
NCUA Regulatory Alert 96-RA-3 SAR Software Program
NCUA Regulatory Alert 01-RA-11 Suspicious Activity Report
Page 28-8
Chapter 29
SPECIAL ASSISTANCE. LETTERS OF
UNDERSTANDING AND AGREEMENT.
CONSERVATORSHIP. AND SPECIAL ACTIONS
TABLE OF CONTENTS
SPECIAL ASSISTANCE. LETTERS OF UNDERSTANDING AND

AGREEMENT. CONSERVATORSHIP. AND SPECIAL ACTIONS ........................... 29-1
Examination Objectives ...................................................................................... . 29. 1
Overview ............................................................................................................. . 29. 1
Special Assistance ............................................................................................... . 29. 1
Recommendation for Special Assistance ............................................... ..29.2
Charge to Reserve .................................................................................... 29-3
208 Assistance ......................................................................................... 29-3
Temporary 208 Assistance (Temporary Dividends) ................................ 29-5
Permanent 208 Assistance ....................................................................... 29-6
Non-Cash Assistance .............................................................................. .29.7
Cash Assistance ..................................................................................... ..29.7
NCUSIF Subordinated Notes .................................................................. .29.8
NCUSIF Share Deposits, Loans, and Asset Guarantees ........................ ..29.8
Liquidity Assistance ............................................................................... ..29.8
Returning a Credit Union to Solvency .................................................... .29.9
Resource Sharing ................................................................................................ .29.9
Letters of Understanding and Agreement ........................................................... . 29.1 0
Published LUA ........................................................................................ . 29.1 1
Non-Published LUA ............................................................................... . 29.1 1
LUAs in FISCUs ..................................................................................... . 29.1 2
Merger. Purchase and Assumption ..................................................................... .29.12
Board Action Memorandum (BAM).................................................................... 29-13
Conservatorships................................................................................................. . 29.1 4
Special Actions ................................................................................................... . 29.1 6
Assignment of Special Action Cases ...................................................... . 29.1 6
Goals of Special Actions ......................................................................... . 29.1 7
Training for Special Actions .................................................................. ..29.17
The National Teams (TNT)...................................................................... 29-1 8
References ........................................................................................................... . 29.1 8
Chapter 29
SPECIAL ASSISTANCE, LETTERS OF

UNDERSTANDING AND AGREEMENT,
CONSERVATORSHIP, AND SPECIAL ACTIONS
Examination Determine appropriate timing and type of special assistance for
Objectives troubled credit unions
0 Determine appropriate use, type, and language of Letters of
Understanding and Agreement (LUAs) to resolve credit union’s
problems
Determine the appropriate use of options of merger, purchase and
assumption (P&A), or conservatorship to resolve credit union’s
problems
Determine when to recommend supervision of the credit union to
special actions
Associated 0 Liquidity risk can occur when members, vendors, and suppliers do
Risks not have sufficient confidence in the credit union to continue doing
business;
0 Strategic risk can occur when management does not institute
proper planning or provide resources to carry out necessary credit
union operations in a safe and sound manner; and
Reputation risk can occur when problems escalate to the point of
threatening the future viability of the credit union.
Overview Resolving serious credit union problems can involve the use of various
types of special assistance, the issuance of an LUA, merger, P&A,
conservatorship, or the assignment of the credit union to special
actions. The examiner must have fundamental knowledge of the types
of special assistance available, and when to use each type. LUAs, a
supervisory tool, clarify the actions a credit union agrees to take (or not
take) to resolve identified problems. The examiner must have
knowledge of the difference between a published and a non-published
LUA.
Page 29-1
EXAMINER’S GUIDE
Occasionally, efforts to resolve problems do not produce successful

results. The examiner must then determine the appropriate remedy for
the credit union, which may include merger, P&A, or conservatorship.
Regional staff may decide to recommend for assignment to special

actions a credit union that (1) presents a risk of loss to the National
Credit Union Share Insurance Fund (NCUSIF), and (2) needs complex
and time intensive supervision. The regional director assigns cases to
special actions based on the recommendations of staff.
Special The FCUAct provides the NCUA Board, or its representative, the
Assistance discretion and the authority to provide special assistance to federally
insured credit unions. Normally, by the time NCUA considers special
assistance, it has exhausted all other supervisory solutions. Credit
unions request special assistance through the regional director. The
approval of special assistance falls within delegated authority;
however, the NCUA Board may, at their discretion, review these
requests.
Special assistance is not a grant. Credit unions receiving special

assistance to continue independent operations must justify receiving
the special assistance, and demonstrate that the assistance will help
make the credit union a financially viable, self-sustaining institution.
NCUA carefully evaluates all assistance requests in terms of both the
effect on the NCUSIF and the credit unions involved.
NCUA Instructions and the Office of Examination and Insurance’s

Special Assistance Manual contains detailed instructions regarding the
use of special assistance and the processing of requests for special
assistance.
Recommendation An examiner’s on-site contact at the credit union should support each
for Special request for special assistance. When possible, NCUA examiners
Assistance should make joint contacts at state credit unions with state examiners.
Regional management and the state supervisor determine the scope of
a contact in a state credit union.
~~
Page 29-2
SPECIAL ASSISTANCE, LETTERS OF UNDERSTANDING AND AGREEMENT,
If examiners determine the need for assistance during a normal

examination or supervision contact, they will not recommend special
assistance to credit union officials before discussing the case with the
supervisory examiner and advising the regional director.
After deciding to recommend special assistance, the examiners or

regional office staff should work with the credit union officials and
employees to develop a workout plan that addresses the entire
problem, provides for needed correction, and returns the credit union
to normal operations within a reasonable period. Examiners submit the
recommendation, including complete and comprehensive related data,
to the regional director. The recommendation summarizes (1) the type
and amount of assistance needed, (2) the basic problem causing the
need for assistance, and (3) future prospects.
Charge to 5702.40 1(c) and 574 1.3(a)(2) of NCUA’s Rules and Regulations
Reserve allows the board of directors of a federally-insured credit union to
authorize charges to the regular reserve for losses, provided the
charges will not cause the credit union’s net worth classification to fall
below well capitalized.
All other charges to the regular reserve must receive the approval of
the appropriate regional director or, if state-chartered,the appropriate
state official.
208 Assistance §208(a) of the FCUAct authorizes special assistance for the following
purposes:
Reopening a closed, insured credit union; preventing the threatened

closing of an insured credit union; or assisting in the voluntary
liquidation of a solvent credit union;
Protecting the NCUSIF or the interest of the members of the credit
union; or
0 (1) Reducing risk, (2) averting a threatened loss to the NCUSIF
and facilitating a merger or consolidation of one insured credit
union with another, or (3) facilitating the sale of assets of an open
or closed credit union to an assumption of its liabilities by another
person.
Page 29-3
EXAMINER’S GUIDE
NCUA may grant $208 assistance (208 assistance) when the NCUA
Board determines that such action will protect the NCUSIF or the
interests of the members of the credit union. A written agreement must
accompany $208 assistance. Field staff monitors all $208 assistance
cases monthly using SATEX and the Risk Management System
(RMS).
NCUA may provide $208 assistance to (1) critically undercapitalized

credit unions, (2) uncapitalized new credit unions, and (3) credit
unions “in danger of closing.” The following characteristics define a
credit union in danger of closing:
A credit union subject to mandatory conservatorship, liquidation,

or other corrective action provided in $702.204(c) or §702.305(c)
of the NCUA Rules and Regulations and unable to increase net
worth sufficiently through net income retention or other sources
(e.g. secondary capital);
A credit union subject to discretionary conservatorship or
liquidation as provided by $702.203(c), or required to merge as
provided by $702.203(b)(12);
A new credit union subject to discretionary conservatorship or
liquidation as provided by $702.304(c). (See the E&I Special
Assistance Manual, Chapter 1, for specific information); or
A credit union subject to a high probability of sustaining an
identifiable loss (e.g. fraud, unexpected and sudden outflow of
funds, operational failure, natural disaster, etc.) that would result in
a critically undercapitalized status or subject it to conservatorship
or liquidation under §702.304(c).
$208 assistance may be temporary or permanent in nature. Generally,

NCUA limits temporary $208 assistance, in the form of temporary
dividends, to two quarterly (or six monthly) dividend periods for all
dividends including dividends on regular shares, non-member shares,
share certificates, and other share accounts.
NCUA normally limits permanent $208 assistance (subsequent to any

temporary assistance period) to a 24-month workout period.’ For all
Historical experience has shown that workout periods of longer than 24-months are
not likely to succeed. The timeframe is also consistent with the timeframes included
in PCA.
Page 29-4
approved permanent $208 assistance requests, the regional director

issues an LUA outlining the terms and conditions of the assistance.
Permanent $208 assistance may consist of either non-cash or cash

assistance. Non-cash assistance includes a Prior Undivided Earnings
Deficit (PUED) - NCUSIF Guaranteed account, NCUSIF guaranteed
line of credit, or an asset (loan) guarantee. Cash assistance includes a
NCUSIF loan, NCUSIF share deposit, NCUSIF subordinated note, or
an asset purchase.
The request for assistance must justify that the proposed plan reflects
the best alternative for the credit union members and is in the best
interest of the NCUSIF. The regional director ensures that the request
includes documentation of the resolution alternatives considered, the
estimated costs, and information to support cost estimates. If an
alternative other than the one selected would cost the NCUSIF less, the
region must specifically address and clearly support the reason for not
selecting the least costly alternative.
Temporary 5208 Federally insured credit unions with deficits in undivided earnings
Assistance may not disburse dividends without NCUA’s approval. The credit
(Temporary union must submit to the regional director a written request for NCUA
Dividends)
approval to pay reasonable dividends. NCUA approves temporary
dividends to prevent the collapse of the credit union while providing
time to correct root problems, make necessary management changes,
provide clean financial statements, and/or prepare the credit union for
merger, purchase and assumption, or liquidation. NCUA must not use
temporary dividend authority to delay strong corrective action.
NCUA’s approval of temporary $208 assistance allows the credit

union to establish a temporary Prior Undivided Earnings Deficit
(PUED) - NCUSIF Guaranteed account up to a maximum estimated
deficit amount and to pay dividends for a maximum of two quarters or
six months. Temporary dividends exceeding two quarters or six
months require NCUA Board approval.
NCUA grants dividend authority in quarterly (three-month) increments

and the credit union must make a separate request for each quarterly
period. When the credit union declares and pays dividends monthly,
Page 29-5
EXAMINER'S GUIDE
the regional director will approve each monthly dividend payment

contingent upon receipt and approval of the credit union's proposed
dividend rates, anticipated dividend expenses, and resulting PUED.
The NCUA Board delegated to the regional directors and the Office of
Examination and Insurance authority to authorize a credit union with a
deficit in Undivided Earnings to continue paying dividends. The
estimated deficit in Undivided Earnings determines the amount of
assistance provided. SUP 3 (2), Delegation of Authority outlines the
amounts delegated and concurrence requirements.
NCUA grants temporary dividend authority as temporary $208

assistance with minimal documentation. Requests for temporary $208
assistance (temporary dividends) must contain enough information to
demonstrate the benefit to both the credit union and the NCUSIF to
continue operating the credit union. Refer to the Special Assistance
Manual for details on preparation of a request for temporary dividends
requiring concurrence from the Office of Examination and Insurance.
Permanent 5208 The NCUA may grant permanent special assistance to a credit union
Assistance continuing independent operations, if the credit union proves it can
maintain a viable, self-sustaining status.
The credit union must have in place the following nine preliminary
requirements before requesting permanent special assistance:
1. Viable field of membership

2. Capable management
3. Accurate and current books
4. Full and fair financial disclosure
5. Proper written policies and procedures (or realistic plan to put
them in place)
6. Approved net worth restoration plan or risk based plan (including
the impact of repayment of assistance)
7. Positive track history of financial performance and resolving
problems
8. Correction of root problems
9. System for monitoring on-going performance
Page 29-6
CONSERVATORSHIP,AND SPECIAL ACTIONS
The Office of General Counsel should review cases where credit union
officials need to replace ineffective or incompetent management before
the credit union may receive permanent $208 assistance. The Office of
General Counsel should also review cases when NCUA denies a
request for permanent $208 assistance because the officials failed to
remedy noted management deficiencies.
Non-Cash Non-cash assistance includes Prior Undivided Earnings Deficit

Assistance (PUED) - NCUSIF Guaranteed accounts and NCUSIF asset
guarantees.
Prior Undivided Earnings Deficit (PUED) - NCUSIF

Guaranteed Account. Since no credit union with a deficit in
undivided earnings may pay dividends, the credit union may
request non-cash $208 assistance in the form of a PUED - NCUSIF
guaranteed account. The credit union will transfer the deficit
amount in undivided earnings to this account and footnote the
assistance on its financial statements.
0 NCUSIF Asset Guarantee. After exhausting all remedies, the best

business decision for NCUA and the NCUSIF may involve
arranging a merger or P&A. They may also explore liquidating the
problem credit union using an asset guarantee when (1) they cannot
readily determine the fair value of the assets, (3) they need to
expedite the situation, or (3) they question whether they can
recover the full value of the assets. The region must demonstrate
and support significant savings to the NCUSIF in its
documentation and justification.
NCUA approves asset guarantees only in rare situations and normally

for short periods of time (less than twelve months.) The region must
provide justification in the concurrence package if the requested asset
guarantee exceeds twelve months. When considering levels of
delegated authority, the total amount of the guarantee constitutes non-
cash $208 assistance.
Cash Assistance Cash assistance includes NCUSIF subordinated notes, NCUSIF share
deposits, NCUSIF loans, and asset purchases. The LUA may restrict
Page 29-7
EXAMINER’S GUIDE
the use of cash $208 assistance to specific purposes, such as funding of

share withdrawals, short-term investments, the hiring of qualified
management, etc.
NCUSIF NCUA uses this assistance in problem credit unions when a cash
Subordinated infusion by the NCUSIF at minimal or no cost to the credit union will
Notes restore profitability and result in a financially viable, self-sustaining
credit union.
An NCUSIF subordinated note is a subordinated liability with

repayment terms that may include “incentive forgiveness.” The credit
union may earn forgiveness by meeting pre-established goals tied to
specific financial or operational performance benchmarks. Often,
NCUA bases forgiveness provisions upon a percentage of quarterly net
income.
Generally, NCUA provides cash infusions in the form of subordinated

notes that the credit unions repay to the NCUSIF. However, as part of
some workout plans for the most severe cases, credit unions may earn
“incentive forgiveness” of part of the cash assistance by meeting
performance goals and benchmarks defined in the assistance LUA.
When NCUA includes incentive forgiveness in assistance plans, the

credit unions may write-off part of their undivided earnings deficits, or
other types of losses, against the cash assistance. The credit union will
not repay incentive forgiveness to the NCUSIF. Instead, it will record
the incentive forgiveness as income to the credit union.
NCUSIF Share In some cases, a $208 assistance workout plan may include (1)
Deposits, Loans, NCUSIF share deposits in the credit union, (2) NCUSIF loans to the
and Asset credit union, or (3) NCUSIF purchases of specific credit union assets.
Purchases
The regional director defines the terms and conditions of these special
assistance accounts in the LUA or other contractual agreement
developed as part of the assistance plan.
Liquidity A credit union may need liquidity assistance when emergencies or

Assistance situations such as sponsor problems, natural disasters, embezzlements,
Page 29-8
or other problems arise. A credit union may request an NCUSIF

guaranteed line of credit in cases where the corporate credit union or
other credit provider refuses to extend or increase the credit union's
available line of credit.
Credit unions receiving a guaranteed line of credit must be insolvent or

in danger of closing. Delegated authority limits the term of the
guarantee to two years and the amount to $5 million. Requests that
exceed the delegated limits require NCUA Board approval. The
Special Assistance Manual contains details on requesting a NCUSIF
guaranteed line of credit.
Returning a No single workout plan exists for all the problems encountered in
Credit Union to credit unions. Successful workout plans combine results-oriented
Solvency management with results-oriented supervision. Successful resolution
requires that everyone understand the nature of the problem and the
urgency of resolving it. Success hinges on the quality of management
and a viable field of membership.
Following is a general workout strategy:
Retain capable management and operations personnel, whom the

board of directors holds accountable for the results;
Establish basic credit union operations;
Generate current, accurate records including fully and accurately
reconciled general ledger accounts;
Meet h l l and fair disclosure provisions;
Review all expenses and gain operational efficiencies;
Establish the credit union's business strategy for lending and
shares, fee income, and operating expenses and incorporate these
into a net worth restoration plan or business plan; and
Implement the net worth restoration plan or the business plan with
the support of all levels of personnel.
Resource Resource sharing takes known, proven managers or other professionals

Sharing and involves them in resolving the credit union's problems. Examiners
and regional office staff recruit people who know how to manage and
invigorate operations to help troubled credit unions.
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EXAMINER'S GUIDE
Each region should maintain a reference file of potential resource

people, who have different areas of expertise. In troubled credit unions,
potential management candidates must meet strict qualification
standards and obtain NCUA approval pursuant to $701.14 of the
NCUA Rules and Regulations.
Letters of Letters of Understanding and Agreement (LUAs) serve as supervisory

Understand- tools. Regional offices sometimes use LUAs as informal
ing and administrative actions because other administrative actions often
Agreement enforce violations of the terms of the LUAs.
An LUA is essentially a contract between NCUA and a credit union.

The credit union agrees to take, or not take, certain specified actions.
Regional directors issue LUAs when credit unions have not adequately
responded to less severe measures, such as Documents of Resolution.
NCUA also requires LUAs for newly chartered credit unions and to
grant permanent special assistance.
Delegation of Authority SUP 16 authorizes regional directors to enter

into LUAs with elected and appointed officials of FCUs and FISCUs.
Regional directors discuss and negotiate publication of LUAs with the
credit unions to prevent unfair surprises to credit unions and their
officials. The regional directors will address the issue of publication in
every LUA between NCUA and a federal credit union by including one
of the following three provisions:*
1. This LUA will not be published;

2. This LUA will be published; or
3. The regional director is reserving for a reasonable time the right to
publish this LUA.3
Specific and clear language in the LUA enables all parties to

understand the expectations. As appropriate, examiners or the regional
office staff prepares the proposed LUAs and tailors them to each case.
Minor modifications and variations of the listed provisions that clearly

communicate the same ideas are acceptable.
This third provision can also specify the period of time within which the RD will
decide whether to publish the LUA or can correlate publication to a specified event
(or the failure of an event to occur).
Page 29-10
Refer to the Special Assistance Manual for additional LUA details,

guidance on LUA language, and procedures for publication.
In credit unions with outstanding LUAs, the examiner must determine

compliance with the LUA and document compliance within the
examination report. The examiner or credit union should support
recommended changes to the LUA by attaching appropriate supporting
workpapers and documentation for the regional office. For credit
unions with special assistance, the regional director must approve
material modifications to LUAs that affect the workout period or
amount of assistance. Depending on the amount and terms, the
modification may require concurrence and approval of the NCUA
Board or the Office of Examination and Insurance.
Once the credit union has corrected the problem areas addressed by the
LUA, the regional director removes the LUA.
Published LUA The Federal Credit Union Act requires the NCUA Board to publish
and make available to the public “any written agreement or other
written statement for which a violation may be enforced by the Board
unless the Board, in its discretion, determines that publication would
be contrary to public intere~t.”~ The NCUA Board will publish an LUA
if the Board can legally enforce the violations.
The NCUA Board may take administrative actions against credit

unions or officials that fail to meet terms of published LUAs.
Violations of the terms of a published LUA alone constitute grounds
for administrative actions and, although not required, the LUA may
include language to that effect. This provides evidence that the
officials know, or should know, of the consequences of
noncompliance.
Non-Published NCUA may take an administrative action, even when it has not
LUA published the LUA if the credit union (1) fails to comply with the
terms of the LUA, (2) conducts itself in a way that constitutes a
safety and soundness violation or violation of law or regulation.
12 U.S.C. 1786(s)(l)(A).
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EXAMINER'S GUIDE
LuAS in FlscuS An LUA issued to a Federal Insured State Chartered Credit Union
(FISCU) by a state supervisory authority need not address publication
unless required by state law or regulation. NCUA, together with the
state supervisor, may jointly issue an LUA to a FISCU. In such
instances, the requirement for publication applies if NCUA attempts to
take action based on a violation of the terms of the LUA. Therefore,
regional directors will include one of the three publication provisions
discussed above in all LUAs issued jointly with NCUA and a state
supervisory authority.
Merger, A merger or P&A with or without special assistance may serve as an

Purchase and alternative when a credit union cannot feasibly continue operations.
Assumption NCUA staff should make every effort to find a merger or P&A partner
that will minimize loss to the share insurance fund and will allow
service to continue to the field of membership. Examiners should
avoid mergers that solve a short-term exposure to the NCUSIF but
have the potential to create long-term exposure.
Crucial to every merger is management's ability to successfully deal

with the problems in the merging credit union. A documented analysis
of management's ability to handle the proposed consolidation should
support information provided to the regional director and the Office of
Examination and Insurance. Also, examiners should prepare a
summary of the effect on the financial condition of the assuming credit
union (i.e., pro-forma consolidated financial statements and key
ratios.)
In a merger, the continuing credit union absorbs the rights of members

and creditors and the credit union's assets and liabilities. The merging
credit union simply becomes a part of the continuing credit union.
Accordingly, the continuing credit union must honor all legal
commitments, except a commitment or liability assumed before
merger by a third party, usually the NCUSIF. In a merger, liquidation
of the merging credit union never occurs.
In a P&A, the purchasing and assuming institution buys only specified

assets and assumes only certain specified liabilities, which may include
share accounts, after NCUA places the credit union into liquidation.
Those assets not purchased and liabilities not assumed, including any
Page 29-12
contingent or unrecorded, become the responsibility of the NCUSIF.

The P&A alternative enables the NCUSIF to repudiate or invalidate
various contracts that the assuming institution deems unacceptable.
Only credit unions can merge with one another. Statutorily, the
operations of a credit union cannot merge into a bank or a savings and
loan. However, as a legal and, in some cases, a practical alternative, a
bank or an S&L can purchase and assume a credit union's assets and
liabilities. Consequently, when necessary, NCUA may expand its
consideration to banks and S&Ls. In such cases, the approval process
will involve the bank or S&L regulator and insurer.
Negotiations for any special assistance to facilitate a merger or P&A

start with the known and the estimated losses (estimated cost to the
share insurance fund) as of the effective date. The assistance amount
should not exceed the estimated loss to the NCUSIF in the event of a
liquidation as of the same date. The field of membership and assets
and deposits represent value that the continuing credit union should
consider when negotiating a merger or a P&A.
The district examiner, working with the credit union, the supervisory
examiner, and the regional staff, should contact potential merger or
P&A partners. A competitive bidding process often reduces the
ultimate cost to the NCUSIF. The examiner should refrain from
discussing the type and amount of assistance, and should encourage the
potential merger or P&A partners to perform their own due diligence.
NCUA staff must take appropriate steps to control the disclosure of
confidential information. The examiner will obtain the consent of the
regional director before accepting or expressing approval of any
proposal. Final approval of every merger rests with the regional
director or the NCUA Board.
Board Action The regional director requests authority not delegated and requiring
Memorandum action by the NCUA Board in the form of a board action memorandum
PAM) or BAM. Prior to submission to the NCUA Board, the action requested
by the regional director may require concurrence of other offices
(Examination and Insurance and General Counsel). The regional
director should also solicit the views of the Office of Credit Union
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EXAMINER’S GUIDE
Development when one of these actions involves a low-income credit

union.
The reviewing offices need adequate time to review and respond.

(Refer to the NCUA Correspondence Manual and Board Meeting
Schedule for further information.)
The Special Assistance Manual provides details on the appropriate

backup material for inclusion in a special assistance request.
Comemator- Regional directors initiate conservatorship actions after obtaining

ships concurrence of the Offices of General Counsel and Examination and
Insurance and approval of the NCUA Board (refer to the Federal
Credit UnionAct $206(h)(2)(A)for FISCUs.)
Conservatorships generally should not exceed 12 to 24 months. To

ensure recovery or resolution within a realistic time frame, the region
develops a written plan to resolve immediate problem areas and
documents its prospects for the credit union’s future. The region’s
resolution plan includes estimated time frames for returning the credit
union to the membership, merger, or liquidation. Normally, the
regional director will present the resolution plan at the time of the
request to the NCUA Board for approval of the conservatorship action.
If the region has not completed the resolution plan at the time of the
request for conservatorship approval, it must explain the reasons for
the delay in the BAM. In these cases, the region must provide the
resolution plan to the Office of Examination and Insurance within 30
days of the conservatorship order date.
If the conserved credit union, under the prompt corrective action

regulation requirement, must file a net worth restoration plan or a
revised business plan, the conservatorship manager, in consultation
with the NCUA personnel supervising the credit union, will file the
plan.
Conserved credit unions not subject to the prompt corrective action

regulation must prepare a business plan within 90 days of the
conservatorship order. The plan should include operational and
financial goals and performance benchmarks with target dates.
Page 29-14
NCUA must secure capable operational management upon the

initiation of conservatorship. Regions should maintain a list of
potential conservatorship managers.
Using an advisory board of directors and supervisory committee during

conservatorship provides a training ground for volunteers, a source for
membership feedback and a resource for special projects. NCUA
recommends, but does not mandate, using an advisory board of
directors and supervisory committee.
Actions that will result in exposure of $200,000 or more require the

concurrence of the Office of Examination and Insurance (e.g.,
conversion of a computer system.) The agent of the conservator should
provide sub-agents of the conservator with appropriate written
authorization limits.
Under §207(c) of the Federal Credit Union Act, NCUA may disaffirm
or repudiate any contract or lease within a reasonable period following
appointment as conservator, provided:
The conservator determines the performance of the contract or

lease to be burdensome; and
0 The disaffirmance or repudiation will promote the orderly
administration of the credit union’s affairs.
Responsibility for recommending contracts for repudiation rests with

conservatorship management and NCUA personnel supervising the
case. The conservator or the agent for the conservator has the legal
authority to repudiate a contract. The Office of General Counsel can
advise on repudiation of contracts and will assist in the preparation of
necessary repudiation documents.
Examiners must perform an examination within twelve months of the

order for conservatorship. The credit union must have an audit and a
verification of accounts performed in accordance with the
requirements of Part 7 15 of the NCUA Rules and Regulations.
The region will report on NCUA-operated conservatorship using the

Risk Management System. They will input data into the system using
the SATEX workbook and update the information monthly.
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EXAMINER'S GUIDE
Ending a conservatorship and returning the credit union to the

membership requires NCUA Board approval and the concurrence of
the offices of General Counsel and Examination and Insurance.
Examiners must complete an examination not more than 120 days
before the proposed NCUA Board action to return control to the credit
union membership.
Instituting an LUA may ensure performance of the credit union upon

the termination of the conservatorship. In a conservatorship that has
$208 assistance requiring repayment, the new LUA or the Order for
Removal of Conservatorship must address the repayment.
The Special Assistance Manual contains a checklist that provides

detailed action items beginning with the initiation of the
conservatorship through the removal of the conservatorship.
Special Special Actions identifies, controls, and corrects serious problems in

Act ions short periods of time to maintain the integrity and soundness of the
NCUSIF. NCUA's commitment to strong and responsive problem
resolution does not conform to regional borders, but represents a
national concern. NCUA will use all available resources to accomplish
this task.
Assignment of The regional director assigns cases to the special actions division in
Action each region based on factors such as size, complexity of problems,
Cases effect on district or regional program, degree of potential risk of loss
to the NCUSIF, and political sensitivity. The condition of the credit
union cases assigned to special actions should not require the
dissolution of the credit union, but should provide an opportunity for
resolving the problems and maintaining independent operations.
Unless the regional director approves another examiner, a special

actions problem case officer or capital market specialist should act as
examiner-in-charge of credit unions with outstanding $208 assistance.
The assigned problem case officer takes full responsibility and
accountability for assigned cases. The regional director has discretion
regarding the number of cases assigned to special actions and
individual problem case officers; however, the regional director retains
Page 29-16
responsibility for ensuring adequate supervision of cases assigned to

special actions.
Goals of Special The goals of special actions include the following:

Actions
0 Detecting potential and emerging problems early through effective
district management and evaluation of credit union data;
0 Developing results-oriented supervision practices;
0 Resolving problems in credit unions coded CAMEL 4,5 and large,
complex code 3;
0 Reducing the risk to the NCUSIF;
0 Ensuring placement of competent management;
0 Achieving profitability within six months of assignment;
0 Improving net worth of a new credit union to at lease 2 percent
within 23 months from the effective date a credit union was
classified as critically undercapitalized or uncapitalized.
Training for Training is an integral part of the special actions role in minimizing
Special Actions risk of loss to the NCUSIF. A highly trained and motivated group with
strong technical and decision-making skills ensures the soundness and
consistency of problem resolution nationally. While experience
remains an important "teacher," it cannot entirely replace education for
such a specialized group of examiners.
NCUA holds periodic conferences for special actions personnel. Inter-

regional work, especially in large, complex, and unique situations
provides further training to enhance the different professional and
experience levels in each region. This sharing of experience
encourages consistency to problem resolution that positively affects the
resolution of risk of loss to the NCUSIF.
Regions and the central office's Division of Training and Development

provide examiners specialized training in the areas of commercial
lending, investments, ALM, agricultural lending, and marketing
strategies, as well as negotiation tools, motivation, stress management,
and other courses critical to accomplishing the mission of special
actions.
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EXAMINER'S GUIDE
In addition to special actions personnel, district examiners should have

access to special actions experience and training to improve the level
of risk identification and problem resolution expected from all
examiners. Regional directors encourage this at the regional level
using various means including team jobs with problem case officers as
team members, problem case officers working on examinations with
individual examiners, and individually tailoring training sessions
conducted by special actions staff. The Division of Training and
Development offers specialized training such as the Problem
Resolution Seminars at the national level. Examiners with more
training and experience in the area of special actions can better
minimize the potential for risk of loss to the NCUSIF.
The National At times, a situation may demand too many of a specific region's
Teams (TNT) resources (including experienced, responsible individuals). In these
instances, NCUA has developed specialized national teams to work on
these cases. The national teams receive training to quickly identify the
problems, control losses, determine staffing needs, and resolve the
problems. The national teams usually report to the requesting regional
director, but may report to an alternative management hierarchy, if
available.
NCUA may develop the national teams based upon the following
thresholds:
Asset size $100 million or greater;

0 Estimated potential losses exceed $10 million;
0 Regional identification of a peculiar situation not clearly definable
without swift and significant supervision efforts; or
0 At the request of the regional director.
References 0 FCU Act

- $206
- $207
- $208
- $216
Page 29-18

- $701.14
- $702
- $741.3(a)
Special Assistance Manual
NCUA Delegations of Authority
NCUA Instruction No. 4900, Guidance on Release of Credit Union
Financial Information
NCUA Letter to Credit Unions 0 1-CU-0 1
Page 29-19
d4-29 u
Chapter 30
ADMINISTRATIVE ACTIONS
TABLE OF CONTENTS
ADMINISTRATIVE ACTIONS ..................................................................................... 30-1

Objectives ........................................................................................................... . 30. 1
Overview.............................................................................................................. 30-1
Scope......................................................................................................... 0-2
Examiner's Role ....................................................................................... 30-2
Delivery ................................................................................................... .30-5
Contacts after Delivery .......................................................................... ..30-6
Challenges in U.S. District Court ........................................................... .30-6
Institution-AffiliatedParty ...................................................................... .30-7
LUA Policy Issues.................................................................................... 30-7
Cease and Desist .................................................................................................. 30-9
Grounds..................................................................................................... 0-10
Notice of Charges and Hearing ................................................................ 30-12
Final Cease and Desist Order (Permanent) .............................................. 30- 12
Temporary Cease and Desist Order .......................................................... 0-13
Assessment of Civil Money Penalties................................................................. .30- 14
Grounds..................................................................................................... 0-14
Removal of Officials ........................................................................................... .30- 16
Grounds..................................................................................................... 0-17
Notice of Intent to Remove ..................................................................... .30-18
Immediate Suspension of an Official ...................................................... .30- 19
Prohibitions ......................................................................................................... .30- 19
Grounds..................................................................................................... 0-20
Notice of Intent to Prohibit a Person from Further Participation.............30-20
Immediate Prohibition ............................................................................ .30-2 1
Removal or Prohibition Involving Felony .......................................................... .30-2 1
Conservatorship .................................................................................................... 0-23
Grounds..................................................................................................... 0-24
State Credit Unions .................................................................................. 30-25
Termination of Insurance .................................................................................... .30-25
Grounds..................................................................................................... 0-26
Notice of Charges..................................................................................... 30-28
Notice of Intent to Terminate Insured Status ........................................... 30-28
Notice of Termination of Insured Status .................................................. 30-28
Involuntary Liquidation (Insolvency).................................................................. -30-29
Grounds..................................................................................................... 0-29
Notice of Revocation of Charter and Involuntary Liquidation;
Appointment of Agent ............................................................................. 30-30
Post Liquidation Challenge ..................................................................... .30.30
Revocation of Charter and Involuntary Liquidation of Solvent Credit
Unions ................................................................................................................ ..30.30
Grounds.................................................................................................... 30-30
Notice of Intent to Revoke Charter and Place Into Involuntary
Liquidation ............................................................................................... 3 0-32
Notice of Suspension of Charter and Intent to Revoke Charter and
Place Into Involuntary Liquidation .......................................................... 30-33
Appointment of Agent ............................................................................. 30-33
Notice of Termination .............................................................................. 30-34
Notice of Revocation of Charter and Involuntary Liquidation;
Appointment of Liquidating Agent .......................................................... 30-34
Order to Establish Special Reserves .................................................................... 30-35
Recommending Special Reserves for Losses.......................................... .30.36
References ............................................................................................................ 30-36
Chapter 30
0bjectives 0 Determine the administrative actions available
0 Determine the procedures of the various types of administrative
actions
Associated 0 Reputation Risk. Although reputation risk is the primary risk, the
Risks need for administrative actions most likely results from high risk in
any or all of the remaining six risk areas.
Overview Administrative actions are available to the agency to prevent, alter, or

eliminate serious operational problems in a credit union or, if
correcting the problem is not feasible, to merge or liquidate the credit
union. Administrative actions provide protection to the credit union, its
members, its creditors, the NCUSIF, and the credit union industry in
general. Administrative actions assist those credit unions that have
serious operational or managerial problems that normal supervisory
efforts have not, or cannot, resolve. They are not a convenient shortcut
of NCUA's supervisory responsibilities.
Administrative actions represent the strongest supervisory tool

available to NCUA. The actions generally used to correct problems
and to ensure the continued existence of credit unions include:
0 Cease and Desist;
0 Civil Money Penalties;
0 Removal of Officials;
0 Prohibition; and
0 Conservatorship used to correct problems.
Other more serious forms of administrative action include:
Page 30-1
EXAMINER'S GUIDE
0 Termination of Share Insurance (limited to federally insured state-

chartered credit unions);
0 Liquidation (insolvent federal credit unions);
0 Revocation of Charter (solvent federal credit unions); and
0 Conservatorship as a first step to liquidation.
In some cases, when NCUA initiates an administrative action (for

example, cease and desist or removal actions) an administrative law
judge hears both sides of the case. The administrative law judge
recommends a decision to the NCUA Board. The Board then issues a
final order that adopts, modifies, or rejects the administrative law
judge's findings. The party subject to the order may appeal the final
order through the federal court system. Certain other administrative
actions may be directly challenged in court without an administrative
law judge's involvement; for example, temporary cease and desist
orders, immediate removal/prohibition orders, conservatorship actions,
and involuntary liquidations under Title 11.
Scope The paragraphs that follow refer to the NCUA Rules and Regulations
as 12 C.F.R., followed by the appropriate part or section number, and
cite references to the FCUAct as "§206(h)" followed by an official
citation (in most cases), for example "12 U.S.C. 1786(h)."
Examiner's Role Because administrative actions are time-consuming and expensive for
NCUA and quite serious for the credit union, examiners should try to
resolve a credit union's problems informally whenever possible. Often,
a realistic Document of Resolution and frequent examiner contacts will
resolve problems with no need for administrative action. When
realistic and workable plans do not result in corrective action or
improved condition, however, the examiner should consult with the
Before deciding to take administrative action, the examiner and

supervisory examiner must clearly understand the nature of the credit
Page 30-2
union's problems and why any previous attempts to resolve the

problems failed.
The administrative record must bear out the examiner's concerns about
the credit union. The examiner must compile the administrative record
and generally will serve as the principal witness in any administrative
or judicial hearing. The administrative record is the total collection of
information NCUA needs for decision-making purposes. The record
must present a complete, factual, and fully documented history of the
credit union's problems and the attempts by NCUA and the credit
union to resolve them.
The following conditions generally indicate a persistent, serious

problem that may warrant administrative action:
An unsafe or unsound practice, i.e., any action or lack of action

contrary to generally accepted standards of prudent operation (but
not necessarily contrary to GAAP). The probable consequences of
continuing the unsafe practice would be abnormal risk or loss to
the credit union, its members, or the NCUSIF. Some courts require
an additional factor, that the practice be reasonably related to the
financial integrity of the credit union;
0 A serious violation of law, rule, regulation, agreement with the

board, or condition imposed in writing by the NCUA Board;
Disclosure of the problem in at least one previous examination or

follow-up report, or in the case of federally insured, state-chartered
credit unions, in correspondence released by the state regulator or
NCUA; and
0 A practice or condition that one or more officials, who currently

are unresponsive or are unwilling to take the necessary corrective
steps, can resolve.
Note: These conditions do not exclude other conditions that may

warrant administrative action. Examiner judgment is part of the
evaluative process.
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EXAMINER'S GUIDE
In deciding what, if any, action to take, the examiner should consider

the:
0 Financial condition of the credit union;
0 Interests of the membership;
0 Effect on the NCUSIF;
0 Interest of management in continuing the credit union;
Ability of management to run the credit union effectively;
Sponsor's economic condition;
0 Local economic conditions; and
0 Creditors' interests.
When the examiner and supervisory examiner agree that administrative

action is warranted, the examiner will prepare a memo to the regional
office, noting the supervisory examiner's concurrence. The memo will
usually include:
0 Type of action recommended;
0 Grounds for recommendation, based on FCU Act, NCUA Rules

and Regulations, and this Guide;
0 History and trend of operations since problems first appeared;

supervisory efforts, agreements reached, and corrective action
taken by officials;
0 Probable asset share ratio computation; if insolvent, discussion of

"escape clause" in NCUA Rules and Regulations, 12 C.F.R.
$700.1(j)(l);
0 Discussion of alternatives to the action, such as merger, special

assistance, voluntary liquidation, where appropriate; and
Page 30-4
0 Discussion of why less severe forms of administrative action are

inappropriate. For example, if the credit union is solvent and the
examiner recommends revocation of charter, the memo should
state reasons for not recommending a cease and desist or
conservatorship.
The examiner may recommend administrative action at the conclusion

of an examination or after a supervisory contact. In some cases,
examiners need fiu-ther information before making a recommendation.
The Regional Office should contact the Office of General Counsel for
an Order of Investigation, which will allow issuance of subpoenas for
documents or testimony.
The regional office will review the recommendation for administrative

action. If examiners discover any facts or findings subsequent to the
recommendation they should promptly communicate the information
to the supervisory examiner and regional director.
As the NCUA Delegations of Authority requires, the regional office

will consult with the appropriate central office staff before processing
the administrative actions. For administrative actions that require
NCUA Board approval, the region will submit for review draft Board
Action packages containing the proposed administrative actions to the
Office of General Counsel, the Office of Examination and Insurance,
and any other office that may have interest in the action. Regions must
submit these packages within the timeframes established by the NCUA
Board’s guidelines for submission of draft Board Action
Memorandums (BAMs).
Delivery The regional director usually assigns the examiner to deliver the notice
(or order) to the credit union or individual and to obtain a signed
receipt (typed on copies of the notice) from the person who accepts
delivery. The examiner will give the highest priority to the delivery of
the enforcement action consistent with guidance provided by the
regional director.
Refusal by credit union officials or an individual to accept the notice or

order will not alter its force or effect. If the credit union refuses
delivery, the examiner should place the original notice or order in a
Page 30-5
EXAMINER'S GUIDE
conspicuous place, usually in the credit union's place of business, and

if possible, in view of at least one official. The examiner should
promptly report such an unorthodox delivery, or inability to effect
delivery to the supervisory examiner and note the circumstances on a
copy of the order. If the administrative action includes appointment of
a liquidating agent or a conservator, and the officials refuse to release
the records, the examiner should also promptly report this fact to the
The examiner may provide the credit union or individual being served
general guidance about options and deadlines for response to the notice
or order. Under no circumstances should the examiner discuss matters
requiring legal interpretation of rights and alternatives. Instead, the
examiner should advise the officials to consult Part 747 of the NCUA
Rules and Regulations, the FCUAct, or their legal counsel.
Contacts after The examiner should not handle any inquiries from the media, but
Delivery should direct any such inquiries to the regional director or an associate
regional director. The supervisory examiner, with instructions from the
regional director, will give specific guidance to the examiner regarding
the supervision of the credit union that received a notice or order. In all
cases, the supervisory plan will directly relate to both the type of
administrative action served on the credit union or the person, and the
timeframe for the credit union or the person to exercise the right to due
process (ix., administrative hearing or court challenge), as established
in the FCU Act or the NCUA Rules and Regulations.
Examiners will ofien need to develop additional facts relating to the

charges cited in the enforcement action for NCUA's use in a hearing or
in a final decision on the action being sought. They should give high
priority to these assignments. The examiner should refrain from
making statements during the supervisory contacts that could prejudice
the case or place NCUA in an untenable or insupportable position.
Challenges in In the case of a Temporary Cease and Desist Order, Immediate

U.S. District Suspension or Prohibition, Conservatorship, or Title 11 involuntary
court liquidation, the FCU Act permits a challenge of the Agency's action in
U.S. District Court within 10 days of service of the order. A credit
Page 30-6
union or individual may also sue NCUA even though the FCU Act
does not provide for such.
The examiner must therefore have all findings and support

documentation in order at the time of service. The Agency is
represented in court by the Office of General Counsel and the
Department of Justice or the various U.S. Attorneys' Offices, and these
offices need time to process pleadings. An examiner with reason to
believe that an administrative action will be challenged must notify the
supervisory examiner or the regional office before serving the notice to
allow for timely and effective legal assistance.
Institution- NCUA has the authority to bring removals, prohibitions, cease and
Affiliated Party desist, and civil money penalties against "institution-affiliatedparties,"
defined in §206(r) of the FCUAct, 12 U.S.C. 1786 (r), as:
0 Committee members, directors, officers, employees, and persons

participating in the affairs of a credit union (either regulation or
case-by-case decision may define person participating); and
Independent contractors, including attorneys, appraisers, and

accountants, who knowingly or recklessly participate in a violation
of law, regulation, a breach of fiduciary duty, or any unsafe or
unsound practice, and that violation or breach has caused or is
likely to cause a more than minimal financial loss to the credit
union, or a significant adverse effect on the credit union.
LUA Policy Letters of Understanding and Agreement (LUAs) are supervisory

Issues tools. Some credit unions equate LUAs with informal administrative
actions, because NCUA has, at times, enforced violations of LUA
terms through other administrative actions.
An LUA is essentially a contract between NCUA and a credit union.

The credit union agrees to take, or not take, actions specified in the
LUA. Regional directors issue LUAs when credit unions have not
adequately responded to less severe measures, such as Documents of
Resolution (DORs). NCUA requires LUAs for newly chartered credit
unions and for granting permanent 208 assistance. (Refer to the
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EXAMINER’S GUIDE
Special Assistance, Letters of Understanding and Agreement,

Conservatorship, and Special Actions chapter of the Examiner’s Guide
for further guidance.)
LUA Publication. The FCUAct requires that the NCUA Board

publish and make available to the public “any written agreement or
other written statement for which a violation may be enforced by
the Board unless the Board, in its discretion, determines that
publication would be contrary to public interest.” NCUA must
publish an LUA before it can enforce a violation of one of its
terms. NCUA may enforce a published LUA by bringing an
administrative action (e.g., a Cease and Desist Order or Civil
Money Penalty), and proving noncompliance with the published
LUA.
These publication requirements apply to all LUAs, including those

issued to newly chartered credit unions, as well as those issued in
connection with 208 assistance. NCUA may take an administrative
action, even if the agency did not publish the LUA, if the credit
union fails to comply with the terms of the LUA and the credit
union’s conduct constitutes a safety and soundness violation or
violation of law or regulation.
Delegation of Authority SUP 16, authorizes regional directors to

enter into LUAs with elected and appointed officials of FCUs and
FISCUs. Regional directors discuss and negotiate publication with
credit unions to prevent unfair surprises to credit unions and their
officials.
The regional directors will address the issue of publication in every

LUA between NCUA and an FCU by including one of the
following three provisions:
1. This LUA will not be published;

2. This LUA will be published; or
3. The regional director is reserving for a reasonable time the
right to publish this LUA.
Page 30-8
The regional director forwards copies of all LUAs planned for

publication to the NCUA Board and the Office of General Counsel.
The Office of General Counsel oversees the details of publication.
The FCUAct provides that NCUA may enforce the terms of an

unpublished LUA if the NCUA Board approves non-publication
based upon a finding that publication would be contrary to the
public interest. If the regional director recommends to the NCUA
Board that an LUA not be published because publication would be
contrary to the public interest, and the NCUA Board issues this
determination, NCUA can still enforce the LUA. The regional
director's recommendation must clearly show why publication
would be contrary to public interest. The FCUAct requires a
quarterly written report to Congress summarizing all non-published
LUAs that are enforceable under this exception. NCUA expects
rare use of this exception to publication to only those conditions
that truly justify a conclusion that non-publication is in the public
interest.
0 LUAs with Federally Insured State-Chartered Credit Unions

(FISCUs). An LUA issued to a FISCU by a state supervisory
authority need not address publication, unless required by state law
or regulation. NCUA, together with the state supervisory authority,
may jointly issue an LUA to a FISCU. In such instances, the
requirement for publication applies if NCUA attempts to take
action based on a violation of the terms of the LUA. Therefore,
regional directors will include one of the three provisions discussed
above in all LUAs issued jointly with NCUA and an SSA.
Cease and 12 U.S.C. §§1786(e) and (f) contain NCUA's authority to issue cease
Desist and desist orders; 12 C.F.R. 747, Subpart A contains the rules and
regulations governing cease and desist administrative hearings.
§206(e) of the FCU Act empowers the NCUA Board to issue a notice
of charges and to arrange for an administrative hearing to determine
whether NCUA should issue an order to a credit union or an
institution-affiliated party ordering it or them to either stop certain
activity or to take affirmative action to correct particular problems.
Because there is a minimum of 30 days between serving of the notice
and holding of the hearing, §206(f) authorizes the NCUA Board to
Page 30-9
EXAMINER'S GUIDE
issue a temporary cease and desist order which takes effect

immediately upon delivery. The NCUA Board uses this temporary
order when significant conditions require immediate action. NCUA
usually issues it at the same time it issues a notice of charges and
hearing and it remains in effect until the NCUA Board withdraws it,
the Board issues a final order after a hearing, or a U.S. District Court
lifts it after a challenge.
Grounds The grounds for a cease and desist action are set forth in §206(e) of the
FCU Act. The examiner can recommend taking such action if any
insured credit union or institution-affiliated party is:
0 Engaging in or has engaged in, or the examiner has reasonable

cause to believe that the credit union or the persons involved are
about to engage in, an unsafe or an unsound practice in conducting
the business of the credit union (see the Examiner's Role section
for definition of unsafe and unsound practice); or
Violating or has violated, or the examiner has reasonable cause to

believe that the credit union or persons involved are about to
violate a law, a rule, a regulation, any condition imposed in writing
by the NCUA Board, or any written agreement entered into with
the NCUA Board, as long as the agreement has been published in
accordance with 9 1786(s) of the FCU Act.
A cease and desist order, whether permanent or temporary, is similar to

an injunction. It is usually NCUA's first option when the agency needs
formal action. Cease and desist is useful and effective because it
allows NCUA to stop a current harmhl practice or anticipate and
prevent harmful practices from occurring.
Although a cease and desist order normally resolves a persisting or

recurring problem, NCUA may use a cease and desist action for a first-
time problem that could seriously affect the credit union's operations
and where the officials have indicated they will not take corrective
action.
Page 30-10
While a cease and desist order most often prevents certain actions from
occurring, it may accommodate purposes of affirmative action,
including:
0 Rescission of contracts;
0 Limitations on growth of the credit union;
0 Employment of qualified employees;
0 Disposal of loans or assets; and
0 Restitution, reimbursement, indemnification or guarantees against

loss, which the examiner may order only if the credit union or
institution-affiliatedparty was unjustly enriched or recklessly
disregarded the law or regulation.
A cease and desist action allows resolution of problems in a solvent

credit union while preserving and strengthening the credit union's
corporate and managerial integrity. A cease and desist order is usually
effective in compelling the credit union to take the needed action. If,
however, examiners believe that issuance of a final order would not
affect compliance, they should consider an alternative administrative
action.
The administrative process for issuing a cease and desist order is as

follows:
0 The NCUA Board or regional director issues a Notice of Charges,

setting out the allegations and statement of facts supporting the
charges. The Notice establishes a time and place for a hearing
between 30 and 60 days.
The credit union or institution-affiliatedparty may consent, i.e.,

agree to a final order without contesting the charges. The NCUA
Board then issues a final order without an administrative hearing. If
there is no consent, a hearing is held before an administrative law
judge.
Page 30-1 1
EXAMINER'S GUIDE
0 After the hearing, the administrative law judge sends a

recommended decision and the hearing record to the NCUA Board.
Within 90 days the Board must render its final decision. The Board
may disagree with the administrative law judge, but the evidence
must clearly support the decision.
0 The credit union or institution-affiliated party may, if it disagrees,

appeal to the U.S. Court of Appeals within 30 days after service of
the final order. The court will uphold the NCUA Board's action
unless it finds that action is arbitrary and capricious. The final
order is in effect during the appeal unless stayed or modified by the
court.
0 The Order is effective 30 days after service on the credit union or

institution-affiliated party. Violation of the order could result in
civil money penalties of up to $1,000,000 per day.
Notice of The Notice of Charges and Hearing will contain the specific charges
Charges and and supporting facts. The notice establishes a time and place for a
Hearing hearing before an administrative law judge. The date for the hearing
will be 30 to 60 days after service of the notice unless NCUA had set
an earlier date at the request of the affected party. The examiner should
advise the credit union or institution-affiliatedparty as to the
seriousness of the notice upon its delivery. The examiner should make
the officials aware of: (1) the timeframe in which they must respond by
filing an answer to the allegations, and (2) the need to file a written
notice of appearance with the administrative law judge. The notice will
include this and other instructions.
Final Cease and NCUA will issue and serve a final cease and desist order:
Desist Order
(Permanent) 0 If the credit union or institution-affiliatedparty waives its right to a
hearing and consents to the issuance of the cease and desist order;
or
0 If the NCUA Board, upon review of the hearing record and

recommended decision of the administrative law judge, finds that
Page 30-12
the charges specified in the Notice of Charges and Hearing have

been established.
A cease and desist order becomes effective 30 days after service upon
the credit union and it remains effective, except to the extent an action
of the NCUA or a reviewing court stays, modifies, terminates, or sets it
aside. A cease and desist order issued upon consent becomes effective
at the time specified in the order.
If the credit union or institution-affiliatedparty is in violation of its

terms, NCUA may enforce a final order (or temporary order) by filing
a lawsuit seeking enforcement in U.S. District Court or imposing civil
money penalties (see the Assessment of Civil Money Penalties section
of this chapter.)
Temporary NCUA can issue a temporary cease and desist order before completing
Cease and the normal administrative process when the violation or threatened
Desist Order violation as specified in the Notice of Charges and Hearing will likely:
0 Cause insolvency;
0 Cause a significant dissipation of the assets or the earnings of the

credit union;
Weaken the condition of the credit union; or
0 Otherwise prejudice the interests of the insured members of the

credit union.
The temporary cease and desist order usually accompanies the Notice
of Charges and Hearing. In most cases, it will be part of the notice, but
it may be a separate document. At times, facts developed after the
serving of a Notice of Charges and Hearing may warrant issuing of a
temporary cease and desist order, even though it did not previously
appear appropriate. The examiner should immediately noti@ the
supervisory examiner of any facts that would support such action.
The temporary cease and desist order becomes effective upon service
and remains effective unless set aside, limited or suspended by a court
Page 30-13
EXAMINER'S GUIDE
or the NCUA Board. The temporary order remains effective until

completion of the administrative proceedings held as specified in the
Notice of Charges and Hearing or until the NCUA dismisses the
charges. When NCUA issues a final cease and desist order against the
credit union, the temporary cease and desist order continues until the
effective date of the permanent order. The credit union or the
institution-affiliatedparty subject to a temporary cease and desist order
may challenge the order by filing suit in a U.S. District Court within
ten days after service. The credit union or institution-affiliated party
may be subject to civil money penalties for violating the temporary
order.
The NCUA Board may withdraw a cease and desist order at any time
during the administrative process. This may occur, for example, after
the credit union takes adequate corrective action, executes a letter of
understanding, or otherwise convinces the NCUA Board that it can
safely terminate the administrative proceedings. However, the fact that
a credit union has ceased the practice leading to the Notice, or
promises that it will not recur, does not necessarily mean that NCUA
should terminate the action. The NCUA Board is free to pursue a final
order to ensure that future violations do not occur, or to deter other
credit unions from committing the same unsafe or unsound practices or
violations.
Assessment 12 U.S.C. 0 1786(k) contains NCUA's authority to issue civil money

of Civil penalties; 12 C.F.R. 747, Subpart A contains the rules and regulations
Money governing civil money penalty administrative hearings. The NCUA
Penalties Board may assess civil money penalties against either a credit union or
an institution-affiliatedparty (see definition of institution-affiliated
party above). The FCUAct specifies three tiers of civil money
penalties. For particularly serious violations, assessments may reach
$1,000,000 per day for each day the violation continues, although for
credit unions the maximum is the lesser of $1,000,000 per day or 1
percent of assets per day.
Grounds First tier. Any credit union or institution-affiliated party that

violates a law or regulation, a final order of the NCUA Board, a
published agreement with the Board (such as a Letter of
Page 30-14
Understanding and Agreement), or a condition imposed in a

published writing by the Board in connection with the granting of
any application (such as the Insurance Agreement), may receive a
fine of not more than $5,000 for each day of the violation. First tier
penalties may apply to credit unions that, even after warnings,
repeatedly submit late or substantially inaccurate call reports.
0 Second tier. If the credit union or institution-affiliated party

commits a first tier violation, and exhibits reckless conduct or a
breach of fiduciary duty, and the violation, practice or breach is
part of a pattern of misconduct, or causes more than a minimal loss
to the credit union, or results in a monetary gain or other benefit to
the institution-affiliated party, then the NCUA Board may assess a
civil money penalty of not more than $25,000 per day for each day
of the violation.
0 Third tier. Any credit union or institution-affiliatedparty that

knowingly commits the first tier violations, knowingly engages in
unsafe or unsound practices, knowingly breaches any fiduciary
duty, or knowingly or recklessly causes a substantial loss to the
credit union or a substantial monetary gain or other benefit to a
party because of the violation, breach, or practice, may receive
assessment of a civil money penalty of not more than $1,000,000
per day for each day of the violation, or in the case of a credit
union, 1 percent of assets, whichever is less.
The normal administrativeprocedure for a civil money penalty action

is as follows:
0 The NCUA Board issues a Notice of Assessment, setting forth a

statement of the law and facts on which it bases the assessment.
0 The assessed party has 90 days to make payment, but may request a
hearing within 20 days.
An administrative law judge will hold a formal hearing if

requested.
0 After the administrative hearing, the administrative law judge

submits a recommended decision to the NCUA Board.
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EXAMINER'S GUIDE
The NCUA Board issues its final order.
An institution-affiliatedparty or credit union may appeal to the

U.S. Court of Appeals within 20 days of receipt of the final order.
Removal of 12 U.S.C. §1786(g) contains NCUA's authority to issue a removal

Officials order; 12 C.F.R. 747, Subpart A contains the rules and regulations
governing removal administrative hearings. The administrative action
to remove directors, officers, or committee members as provided in
§206(g) of the FCUAct is available as an initial course of action or as
a continuation of a cease and desist order if the officials refuse to
comply as directed. Whether this enforcement action is an initial
course or a continuation of a cease and desist order, it is separate and
has its own applicability to particular situations.
In some cases involving a breach of fiduciary duty on the part of the

director, the officer, or the committee member, discharge of the
responsible person is an internal matter performed by the board of
directors. On occasion, the director, the officer, or the committee
member will voluntarily resign. It may be necessary to initiate formal
removal proceedings, however, when internal or voluntary solutions do
not work.
Removal of a director, an officer, or a committee member is not

anticipatory in nature as in the cease and desist action. Removal is
appropriate only when an official committed an act that constitutes
grounds for removal, i.e., it cannot be imposed for future or threatened
conduct. Removal can follow only if NCUA has issued a Notice of
Intent to Remove or a Notice of Suspension and Intent to Remove and
after completion of the appropriate administrative proceedings as
provided in the FCUAct and NCUA Rules and Regulations.
NCUA may remove a person who voluntarily withdraws or whose

services the credit union terminated. A removal action may be brought
any time up to six years after resignation, termination of employment,
liquidation, or any other termination of a relationship with the credit
union (see §206(k)(3), 12 U.S.C. 1786(k)(3)).
Page 30-16
Any party who has been removed or suspended from office is also
automatically removed, suspended, and prohibited from participating
in the affairs of any federally insured financial institution without the
express written consent of the appropriate regulatory authority.
Grounds NCUA can remove from office directors, officers, or committee

members when they have:
0 Directly or indirectly violated:
- A statute or regulation; or
- A provision of a final cease and desist order (but not a

provision of an immediate, temporary cease and desist order);
or
- Any condition imposed in writing by the NCUA Board

regarding the granting of any application or other request by the
credit union (e.g., an application for insurance or 208
Assistance); or
- Any published, written agreement between the credit union and

the NCUA Board; or if they have
- Engaged or participated in any unsafe or unsound practice in

connection with the credit union; or
- Committed or engaged in any act, omission, or practice which

constitutes a breach of fiduciary duty; and
0 Because of the violation, practice, or breach described above:
- The credit union has or will suffer financial loss or other

damage; or
- The interests of the members have or could be prejudiced; or
- The party receives financial gain or others benefit because of

the violation, practice, or breach; and
Page 30-17
EXAMINER'S GUIDE
0 Such violation, practice, or breach:
- Involves personal dishonesty by the party; or
- Demonstrates the party's unfitness to serve the credit union or

to participate in its affairs.
An official's past or current violation of the Depositary Institution

Management Interlocks Act is an additional ground for removal.
Following are the administrative procedures for removal:
0 The NCUA Board issues a Notice of Intent to Remove.
0 If the official or employee does not resign or consent, a hearing is

held before an administrative law judge 30 to 60 days after service
of the order.
0 The administrative law judge sends the recommended decision and

the hearing record to the NCUA Board.
0 The NCUA Board issues a final order.
0 The respondent may appeal to U.S. Court of Appeals, but the final
order remains in effect unless modified by the NCUA Board or the
court.
Notice of Intent The notice to remove an official from office contains a statement of
to Remove facts constituting the grounds for removal and will establish a time and
a place for holding a hearing before an administrative law judge,
normally, between 30 days and 60 days serving the notice.
The rules and the procedures contained in Part 747, Subpart A of the
NCUA Rules and Regulations apply to suspension and removal
actions. The examiner should inform the official upon delivery of the
notice that unless the official personally or an authorized representative
appears at the hearing, the judge deems that the official has consented
to the issuance of an Order of Removal. The party may also consent to
the issuance of a removal order to save the time and expense of hiring
Page 30-18
counsel or appearing at the hearing. In this case, rather than holding an

administrative hearing, the matter will go directly to the NCUA Board
for issuance of a final order of removal.
Immediate An immediate suspension is similar to a temporary cease and desist

Suspension of order. If necessary to protect the credit union or the interests of its
an Official members, NCUA can immediately suspend an official from all official
duties pending completion of the administrative hearing. This would
be appropriate, for example, when it appears that the individual, once
served with a notice, likely will cause further loss to the credit union or
destroy credit union records before completion of the hearing or the
issuance of the NCUA Board's final Order of Removal. Like a
temporary cease and desist order, an Immediate Suspension will
usually be a part of or will be served simultaneously with the Notice of
Intent to Remove, although it may be served any time after the notice.
It, too, becomes effective immediately upon service and remains in
effect until dismissed or until the NCUA Board issues a final order.
The official may challenge it in court within 10 days of service, and the
NCUA Board may enforce the order by suing in US. District Court or
by assessing civil money penalties.
Prohibitions 12 U.S.C. §1786(g) contains NCUA's authority to issue a prohibition

order; 12 C.F.R. 747, Subpart A contains the rules and regulations
governing prohibition hearings. A prohibition action is similar to, but
broader in scope, than a removal proceeding. A removal action
removes a person from a specified official position in a credit union,
while a prohibition action stops any institution-affiliated party from
participating in the affairs of a credit union. Because institution-
affiliated parties are not always elected or appointed officials of an
insured credit union, they may not always be removed as directors,
officers, or committee members. Instead, NCUA must prohibit them
from further participation in the affairs of an insured credit union.
The examiner prepares a recommendation for prohibition in the same

manner as other administrative actions. The recommendation includes:
Recipient of the prohibition action, i.e., name of the person,

business address, and position with the company, group or
Page 30-19
EXAMINER’S GUIDE
enterprise (including name of the proprietorship, partnership, or

corporation) and the relationship with the credit union;
0 Sufficient evidence to establish the grounds necessary for a

prohibition action; and
0 Specifics of the prohibition action, e.g., events causing the insured

credit union’s (or the other business enterprise’s) realized or
probable financial loss (or other damage) or events that allowed the
institution-affiliated party to profit.
Prohibition of a person, like the removal of an official, is not

anticipatory in nature as in a cease and desist action. Prohibition can
follow only if NCUA issued a Notice of Intent to Prohibit and
completed the appropriate administrative proceedings or the
institution-affiliatedparty consented. NCUA may combine
proceedings for removal and prohibition if appropriate. The procedures
for a prohibition action are essentially the same as those for a removal
action.
Grounds The grounds are the same as those for removal.
Notice of Intent When NCUA determines that grounds for a prohibition action exist, it
to Prohibit a will serve a Notice of Intent to Prohibit upon the institution-affiliated
Person from Party.
Further
Participation NCUA is not precluded fiom issuing a notice of prohibition where the
person voluntarily withdraws or when the credit union terminates
services after discovering financial loss or other damage. NCUA may
bring a prohibition action any time up to six years after resignation,
termination of employment, liquidation, or any other termination of a
relationship with the credit union (see $206(k)(3) of the FCUAct, 12
U.S.C. 1786(k)(3)).
The examiner will inform the person served with the notice of the
basic requirements regarding the hearing, which is held not less than
30 days and not more than 60 days after delivery, as stated in the
notice. Usually, the region directs the examiner to complete a follow-
Page 30-20
up supervision contact before the hearing date. However, if examiners

do not make a contact or if the examiner learns before the hearing of
additional pertinent information regarding the person and the charges
cited in the notice, they should report this information to the regional
office as soon as possible. The examiner should expect to participate in
the hearing as a witness for NCUA.
Immediate NCUA may issue an immediate prohibition order to protect the credit
Prohibition union or the interest of its members on the same basis and for the same
reasons as an immediate removal of official order. The discussion in
the section, Immediate Suspension of an Official, applies equally here.
Removal or §206(i) of the FCUAct, 12 U.S.C. §1786(1) contains NCUA’s

Prohibition authority to issue a removal or prohibition order for cases involving a
Involving felony; 12 C.F.R. 747, Subpart D contains the rules and regulations
Felony governing prohibition hearings. If examiners learn of any criminal
charges brought against institution-affiliated parties involving
dishonesty or breach of trust, they should report any evidence
supporting a possible felony to their supervisory examiner. In no
instance should the examiner proceed to investigate any complaints or
indictments brought against institution-affiliatedparties without first
consulting with the supervisory examiner.
The examiner will report findings in support of a recommendation to

suspend the official or to prohibit the person, if an official or other
institution-affiliatedparty: (1) has been charged with a crime involving
dishonesty or breach of trust; (2) the crime is punishable under federal
or state law by imprisonment for more than one year; and ( 3 ) the
continued service or participation by such party may pose a threat to
the interests of the credit union’s members or threaten to impair public
confidence in the credit union. The examiner must develop tangible
evidence to show that these grounds exist.
Examples of tangible evidence supporting suspension of the person as

an official could include: (1) a membership meeting called in an
attempt to force the resignation of the official or the termination of a
person’s participation; (2) share outflows; ( 3 ) membership
cancellations directly attributed to general membership dissatisfaction
Page 30-21
EXAMINER'S GUIDE
over the continuation of the person as an official; (4) significant

adverse publicity; or (4) inability of the credit union to obtain loans
from regular sources.
The examiner should refrain from expressing an opinion of guilt or

innocence in the recommendation for suspension or for prohibition.
The suspension or the prohibition remains in effect until the court
finally disposes of the information, the indictment, or the complaint, or
until NCUA terminates the administrative action.
If the final verdict is guilty, and the judgment is no longer subject to

appeal, or if the individual enters a pretrial diversion or other similar
program, NCUA may issue and have the examiner serve upon the
person a final order removing or prohibiting that individual from
participating W h e r in the credit union's affairs. A not guilty verdict
will not preclude NCUA from instituting removal or prohibition
proceedings under the general removal and prohibition provisions
previously discussed. The examiner will need to maintain close follow-
up on the legal proceedings and immediately report to the supervisory
examiner any new developments which may affect the order issued or
pending.
The administrative procedures for felony removal or prohibition are as

follows:
0 The NCUA Board issues a Notice of Suspension andor

Prohibition, effective immediately.
0 The NCUA Board holds no administrative hearing unless the

official or other person requests one from the Board in writing
within 30 days.
0 If the institution-affiliated party requests, the NCUA Board or its

designated hearing officer holds the hearing in Washington, DC.
The hearing is not the type of formal administrative proceeding
held for the other types of administrative actions and does not take
place before an administrative law judge.
Page 30-22
If the court convicts the institution-affiliatedparty, and that

conviction is no longer subject to appellate review, the Board may
issue a final Notice of Removal or Prohibition.
If the court acquits the institution-affiliatedparty, the Board may

still proceed with a removal or prohibition, but it must be a
§206(g)-type removal or prohibition.
0 When a respondent requests an informal hearing, the presiding

officer at the hearing makes his recommended decision to the
Board within 10 days.
0 The Board issues its decision within 60 days.
0 There is no right to appeal the Board's final order.
Conservator- §206(h) of the FCUAct, 12 U.S.C. 1786(h) contains NCUA's authority

ship to place an insured credit union into conservatorship. Conservatorship
is a procedure whereby the NCUA takes immediate possession and
control of a credit union's business and assets and may operate the
credit union until:
0 The NCUA Board permits it to resume business on its own, subject

to any terms or conditions the Board may impose;
0 The NCUA Board transfers possession and control to a state

authority (in the case of a federally insured state-chartered credit
union); or
0 The NCUA Board liquidates the credit union.
Unlike the previous forms of action discussed, conservatorship does

not involve an administrative hearing. The NCUA Board may act "ex
parte without notice," meaning it need not noti6 the credit union of its
intended action or provide it with the opportunity to contest the action
before taking it. Within 10 days after the NCUA Board places a credit
union into conservatorship, however, the credit union may challenge
the action in U.S. District Court. Whether or not the credit union
Page 30-23
EXAMINER'S GUIDE
challenges the conservatorship action, it is effective immediately upon

service of the order to the credit union.
Conservatorship is a particularly useful tool in situations where

management has abandoned the credit union or is totally inadequate to
cope with severe financial problems that must be immediately brought
under control. Conservatorship allows NCUA to influence more
actively the operations of the credit union and to avoid or substantially
reduce any further dissipation of assets.
Conservatorship is also useful when evidence exists of complex illegal

or unsafe practices, but the examiners cannot readily determine the full
ramifications of this activity. Conservatorship precludes management
from having any access to records, and thus avoids the chance that
management can tamper with or destroy vital records. At the same
time, it permits either full or limited member services to continue.
Ideally, conservatorship will result in the credit union being returned to

the members' control. This action requires NCUA Board approval.
Prior to returning the credit union to the members' control, NCUA staff
(other than those who had responsibility for managing the operations
of the credit union) should complete an examination.
Grounds NCUA may take conservatorship action whenever any of the following
grounds are present:
0 The credit union's assets require conserving;
0 NCUSIF's funds are at risk;
0 The members' interests need protection;
The credit union consents to conservatorship by resolution of its

board of directors;
0 The credit union has willfully violated a final cease and desist
order; or
Page 30-24
0 Management conceals or refuses to make available the books and

records for inspection by an examiner or lawhl agent of the NCUA
Board.
0 The Attorney General notifies the NCUA Board that the credit
union has been found guilty of certain criminal provisions.
State Credit In the case of a federally insured state credit union, the FCU Act
Unions provides that written approval of the state regulatory authority is a
prerequisite to conservatorship action. However, if the state does not
provide such approval within 30 days of the NCUA Board's notice to it
that grounds for conservatorship exist, and the NCUA Board responds
in writing to the state's written reason, if any, why the state is
withholding approval, then, a unanimous vote of the NCUA Board can
place the credit union into conservatorship without state approval.
Termination §206(a) of the FCUAct, 12 U.S.C. 1786(a) contains the authority to

Of Insurance terminate an insured credit union's share insurance; 12 C.F.R. $747
Subpart C contains the rules and regulations governing a termination
of insurance action. Although the NCUA Board can theoretically take
this action against a federal credit union, the Board most often reserves
it for federally insured state-chartered credit unions. (Because federal
credit unions must be federally insured, a termination of insurance
would result in liquidation, unless the credit union could convert to a
state charter before completing the proceeding.) Therefore, the
recommended course of action for a federal credit union is immediate
liquidation, if insolvent, or Notice of Suspension of Charter and/or
Notice of Intent to Place into Involuntary Liquidation, for problems
other than insolvency. (See the section of this chapter titled Revocation
of Charter and Involuntary Liquidation of Solvent Credit Unions.)
For federally insured state-chartered credit unions, termination of

insurance is the most severe action NCUA can initiate. It protects the
NCUSIF when the credit union is unwilling or unable to take
corrective action. In this regard, its purpose is similar to one of the
basis for a conservatorship.
Page 30-25
EXAMINER'S GUIDE
Termination of insurance will most likely force the state credit union
into involuntary liquidation unless the credit union has an alternative
share insurance program for which it can qualify and can thereby
maintain member confidence. For these reasons, the regional office
will closely communicate with the state regulatory agency whenever it
contemplates this administrative action against any federally insured
state-chartered credit union. Examiners will not discuss the potential
for an administrative action with the credit union or with the state
regulatory agency unless their supervisory examiners or the regional
director specifically directs them to.
Grounds The grounds for a termination of insurance action are essentially the
same as those for a cease and desist action:
0 Unsafe or unsound practices or conditions; or
0 Violations of law, rule, regulation, any condition imposed in

writing by the NCUA Board, or any written agreement entered into
with the NCUA Board. To be enforceable, the Board must have
previously published the agreement. Publication requires issuance
of a press release and availability of the agreement to the public.
Termination of insurance action serves as an initial course of action or

as a continuation of a cease and desist order if the officials refuse to
comply as directed. Examples of conditions that might warrant a
recommendation for termination of share insurance include:
0 Insolvency as defined in $700.2(e) of the NCUA Rules and

Regulations, and the unwillingness of the credit union's board of
directors or state regulator to place the credit union into
involuntary liquidation or to act appropriately to minimize risk and
potential loss to the NCUSIF; or
0 Abandonment of the credit union's operations by the elected and

the appointed officials, and the state regulator's inaction to
minimize risk and potential loss to the NCUSIF; or
0 Plant closing, extended work stoppage, or breakdown in

membership confidence that causes a major outflow of shares and
Page 30-26
of liquidity, or general mismanagement of the operations by the

officials that is causing or will cause an insolvent condition, and
the officials or state regulator not acting to minimize risk and
potential loss to the NCUSIF; or
An unsafe or unsound practice or a serious violation of an

applicable law, rule, regulation, order, or any condition imposed by
the NCUA Board that is causing or will cause an insolvent
condition, and the officials or state regulator not acting to minimize
risk and potential loss to the NCUSIF.
Following are the administrative procedures for termination of

insurance:
The NCUA Board issues a Notice of Charges, with a request for

corrective action. The credit union has 120 days to make such
corrections, although the Board may reduce this time to not less
than 20 days if the insurance risk is sufficient.
If the credit union does not take corrective action, then the NCUA
Board may issue a Notice of Intent to Terminate Insured Status.
This sets out a statement of the facts justifying termination, and
establishes a time and place for an administrative hearing within 30
to 60 days.
An administrative law judge holds an administrative hearing.
The administrative law judge files a recommended decision with

the NCUA Board.
The NCUA Board issues its final order.
The credit union may appeal to the U.S. Court of Appeals, but the
order is effective unless modified or lifted by the Board or the
court.
NCUSIF insurance continues for one year from the date of

termination on current shares; however, the NCUSIF does not
insure new shares.
Page 30-27
EXAMINER'S GUIDE
Notice of As a preliminary step to a Notice of Intent to Terminate Insured Status

Charges and if conditions warrant, NCUA will issue a Notice of Charges to the
credit union, with a copy to the state regulatory agency. This notice
will contain a statement describing the unsafe or unsound practices,
conditions or relevant violations. This notice will request that the
credit union correct the practices, the conditions, or the violations
within 120 days after service of the notice. NCUA may set a shorter
timeframe of not less than 20 days if it determines that any further
delay may unduly subject the NCUSIF to greater risk or if the state
regulatory agency requires a timeframe shorter than 120 days.
The Notice of Charges may motivate the officials to take the necessary
corrective action. The region may assign the examiner to investigate
the circumstances and the events in the case as a preliminary step in
the process of issuing a Notice of Charges. In such an event, the
examiner must identify the unsafe or unsound practices or serious
violations and establish supporting facts that constitute grounds for the
action. The examiner's analysis of the circumstances should provide
sufficient evidence to proceed with the Notice of Intent to Terminate
Insured Status if the credit union fails to correct the conditions cited in
the Notice of Charges.
Notice of Intent If NCUA pursues the Notice of Intent to Terminate Insured Status, the
to Terminate notice will contain a statement of the facts about the alleged unsafe or
Insured Status unsound practices or violations and will set the time and place for a
hearing. The date of the hearing will be 30 to 60 days after service of
the notice unless NCUA fixes an earlier date at the credit union's
request. The examiner should caution the credit union about the
seriousness of the notice upon its delivery. A copy of the notice is also
sent to the state regulatory agency. The examiner informs the officials
of the time limits for responding to the allegations and that the credit
union or its representative must file a written notice of appearance with
the administrative law judge. These instructions are included in the
notice.
Notice of If a credit union cannot be returned to satisfactory operations and the

Termination of danger of insolvency eliminated, the NCUA Board will terminate its
Insured Status insured status after an administrative hearing. Before the effective date
Page 30-28
of termination of insurance, the credit union is required to mail to each

member and to publish in a newspaper of general circulation the
Notice of Termination of Insured Status. The format for this notice is
specified in $747.207 of the NCUA Rules and Regulations. Specific
duties of the credit union after termination of share insurance are
specified in $747.208 of the NCUA Rules and Regulations.
The credit union is subject to the same duties and obligations of an

insured credit union for one year after the effective date of the Notice
of Termination of Insured Status; shares on deposit when insurance is
terminated remain insured for the following year. Any shares
purchased after the effective date of the final order are not insured by
the NCUSIF. An examiner may be asked to follow up on the final
order to determine if the credit union is fulfilling its duties and
obligations to its members and to the NCUSIF.
Involuntary $207(a)(1) of the FCU Act empowers the NCUA Board to close a
Liquidation federal credit union that is bankrupt or insolvent. This administrative
(Insolvency) action eliminates the credit union as a legal entity. NCUA cannot take
this action against a federally insured state-chartered credit union.
Grounds The grounds for this most severe action is insolvency or bankruptcy as
defined in $700.2(e) of the NCUA Rules and Regulations.
The credit union has no right to a preclosure administrative hearing.

The federal credit union's charter is immediately revoked and the credit
union is placed into involuntary liquidation. The credit union may,
however, challenge the action in U.S. District Court within 10 days. It
is critical, therefore, that the finding of insolvency be based upon
tangible evidence and indisputable circumstances using the most
current information available. The examiner must prepare a
supplemental memorandum for the liquidation package that contains
all significant data to support the recommended action, including an
analysis of the various exceptions set forth in §700.2(e) of the
regulations.
Page 30-29
EXAMINER'S GUIDE
Notice of The notice will be served on the federal credit union in the same
Revocation of manner as previously discussed for notices or final orders involving
Charter and solvent federal credit unions. The order is effective immediately upon
Involuntary service, and all assets, books and records of the credit union
Liquidation; immediately become the property of the NCUA. Agents for the
Appointment of Liquidating Agent will be appointed as provided in §207(a) of the
Agent FCU Act.
Post A credit union placed into involuntary liquidation pursuant to §207(a)

Liquidation has the right to challenge NCUA's action in U.S. District Court within
Challenge 10 days after liquidation. It is therefore imperative that the
administrative record adequately supports insolvency. The examiner
must be prepared to testify in court to establish the reasonableness of
the insolvency calculation. For this reason, involuntary liquidations
require the concurrence of the Office of General Counsel to ensure that
the liquidation package is legally sufficient.
Revocation of The authority to place a solvent federal credit union into involuntary
Charter and liquidation is contained in §120(b)(l) of the FCUAct, 12 U.S.C. 1766
Involuntary (b)( 1). The rules and regulations relating to these administrative
Liquidation of proceedings are contained in 12 C.F.R. Part 747, Subpart E. The effect
Solvent of this action is the elimination of a federal credit union as a legal
Credit Unions entity after due process provided for by 4 120(b) of the FCU Act and
Part 747, Subpart E of the NCUA Rules and Regulations. It is the most
drastic enforcement action that can be taken against a solvent federal
credit union.
Grounds Pursuant to the authority in 8 120(b)(1) of the FCU Act, the NCUA
Board may suspend or revoke the charter of a federal credit union that
has violated any provision of its charter, its bylaws, the FCU Act, or
NCUA regulations. This type of action may also be taken for reasons
of bankruptcy, but generally is initiated under $207 of the FCU Act.
Examples of conditions that may warrant recommending revocation of
charter in a solvent credit union are:
0 Abandonment of the credit union's operations and affairs by the

officials; or
Page 30-30
Plant closing and officials refusing to vote to present the question

of liquidation to the members. Such plant closing may force
insolvency under the concept of an ongoing concern, or may cause
a dissipation of the assets and expose the creditors and the
NCUSIF to a greater than normal risk; or
0 Other specific serious violations of its charter, its bylaws, the FCU
Act, or regulations that cannot be reversed and that may cause
insolvency; or
0 Serious operational deficiencies that the officials have not acted to

correct and which, if allowed to continue, may cause insolvency.
Abandonment shall be deemed to have occurred when all or most of

the elected and the appointed officials have demonstrated by their
actions, or failure to act, an intent to end operations. Proof is evidenced
when an active quorum cannot or will not be formed by the remaining
officials.
Because of the significant effect revocation of charter will have on the

membership, the examiner should ensure that the grounds for
revocation are indisputable and represent the most logical solution to
the credit union's problems. For this reason, the revocation of a charter
will not be initiated without a recent examination or supervision
report. The examiner should prepare a supplemental memorandum to
support the recommended action. Following are the administrative
procedures for a revocation of charter:
0 NCUA issues a Notice of Intent to Revoke Charter and Place into

Involuntary Liquidation or a Notice of Suspension of Charter and
Intent to Place into Involuntary Liquidation. If a Notice of
Suspension is issued, operational control of the credit union is
immediately transferred to NCUA. All subsequent administrative
steps are the same for both a Notice of Intent and a Notice of
Suspension.
0 The credit union has 40 days in which to:
- File a written statement stating why it should not be liquidated,

or
Page 30-31
EXAMINER'S GUIDE
- Request an oral hearing, or

- Consent to liquidation by a board of directors' resolution.
If the credit union files a written statement, the NCUA Board will
render a decision within 45 days. A Notice of Revocation of
Charter and Involuntary Liquidation will be issued where the
grounds for liquidation are found to exist.
0 If the credit union requests a hearing, it will be held before an

administrative law judge.
The judge submits the recommended decision to the NCUA Board.
0 The NCUA Board issues a final order.
Notice of Intent The examiner will recommend a Notice of Intent to Revoke Charter
to Revoke whenever the timeframe for due process will not create a greater risk
Charter and of loss to the members, the creditors, and the NCUSIF than exists at
Place Into the time of the recommendation. The examiner should be aware that
Involuntary the credit union will continue to conduct business during the effective
Liquidation time of this notice.
The examiner will determine whether or not a greater risk for loss
exists by allowing the credit union to conduct business in the interim
based on the conditions and the circumstances in each case. However,
if a greater risk for loss is likely to exist, a recommendation for
conservatorship or a Notice of Suspension of Charter and Intent to
Revoke Charter and Place Into Involuntary Liquidation may be
appropriate. This latter action is discussed in the following subsection.
The credit union has 40 days from the date the Notice of Intent is
served to:
0 File a written statement with NCUA setting forth the reasons why
it should not be placed into involuntary liquidation; or
0 In lieu of a written statement, request that an oral hearing be

conducted in accordance with Part 747 of the NCUA Rules and
Regulations; or
Page 30-32
Consent to the Notice by resolution of its board of directors.
The written statement, request for an oral hearing, or consent must be

accompanied by a certified copy of a resolution by the board, signed by
the president and the secretary authorizing such statement, request, or
consent.
At the time of delivery of the Notice, the examiner will advise the
officials of their options and of the timeframes within which their
options must be exercised. The examiner must make it known to the
officials that if the credit union fails to exercise any of its alternatives
as provided in the NCUA Rules and Regulations within the prescribed
timeframes, it will be deemed to have consented to the action being
sought by NCUA.
Notice of The examiner will recommend immediate suspension of charter

Suspension of whenever NCUA must act immediately to protect the interests of the
Charter and members, the creditors, and the NCUSIF. All business by the credit
Intent to Revoke union ceases except for the collection of loans, interest, and late
Charter and charges; the collection of other funds legally due the credit union; and
Place Into the payment of accounts payable and necessary operating expenses.
Involuntary NCUA will normally take immediate possession of all records and
Liquidation property of the credit union. Such immediate suspensions of charters
are rare, since normally the same result can be achieved by placing the
credit union into conservatorship.
The Notice of Suspension of Charter will contain a statement of the

grounds for the immediate suspension and the authority upon which
such grounds are based. Except for the statement of grounds
supporting the need for immediate suspension of the charter and the
restrictions placed on operations, the options available to the credit
union will be the same as provided in a Notice of Intent to Revoke
Charter.
Appointment of A recommendation by the examiner that NCUA appoint an agent

Agent pursuant to a Notice of Suspension to take possession of all books,
records, assets, and property of the credit union will be appropriate
whenever it is apparent that the officials are unwilling or unable to
Page 30-33
EXAMINER'S GUIDE
cope with their serious problems. A breakdown in the maintenance of

the books and the records or abandonment of the credit union by the
officials will be sufficient grounds to recommend appointment of an
agent.
The appointed agent usually will be the district examiner, who will
maintain, or have maintained, the records of the credit union and will
open the credit union for restricted business activity. The credit union's
surety bond coverage should be extended to cover the agents for the
NCUA Board and arrangements should be made with the credit union's
depository to honor the signature of the agents.
The duration of the agent's responsibility will extend until the credit
union is placed into involuntary liquidation, the administrative action
is withdrawn, or the appointment is rescinded, whichever comes first.
Notice of If the credit union officials have eliminated the serious problems cited
Termination in the Notice, a termination of the administrative action may be
warranted. Documentation must be presented supporting the
conclusion that the charges cited in the Notice no longer exist.
Notice of Once a Notice of Revocation of Charter is issued, NCUA ordinarily

Revocation of will appoint the Asset Management and Assistance Center (AMAC)
Charter and liquidation specialist as the liquidating agent in involuntary
Involuntary liquidations for credit unions closed for reasons other than insolvency.
Liquidation; In certain cases, examiners will be appointed as agents where
Appointment of geography or other factors preclude the liquidation specialist fi-om
Liquidating handling the liquidation.
Agent
This final action will be taken after 40 days from delivery of the Notice
of Intent to Revoke Charter or of the Notice of Suspension of Charter
and Intent to Revoke Charter and Place Into Involuntary Liquidation.
The examiner's recommendation to proceed with this final action will
be supported by appropriate schedules and workpapers prepared on or
about the fortieth day. The report should include specific comments
and pertinent information on each charge cited in the notice.
Page 30-34
The examiner also should report whether the credit union exercised
any of the available options. If the credit union files a statement setting
forth grounds and reasons why its charter should not be suspended, the
examiner will analyze it objectively and provide factual evidence to
support or reject the grounds.
Order to Parts 116 and 201 of the FCUAct authorize the NCUA Board to
Establish require that special reserves be established when necessary to protect
Special the interests of federal credit union members. In addition, Part 741 of
Reserves the NCUA Rules and Regulations and the Agreement for Insurance
require state-chartered federally insured credit unions to establish such
reserves as the NCUA Board deems necessary.
The order requires that the reserves be established in an account

entitled "Special Reserve for Losses'' and that they not be transferred
from that account or reduced in any way except by written permission
of the NCUA Board or upon termination of the order. Generally, the
order will affect the credit union's ability to pay dividends. An Order to
Establish Special Reserve for Losses may be necessary under the
following conditions:
0 When the established reserves do not provide sufficient protection

against a condition that threatens the credit union's soundness;
0 When it is believed that the credit union may intentionally evade

the need to establish sufficient reserves;
0 When it is believed that the credit union may ignore the need for
additional reserves; or
When it is believed that the credit union may avoid establishing

sufficient reserves by refinancing or extending loans or
intentionally misrepresenting facts that, if properly disclosed,
would have a material effect.
The Order to Establish Special Reserve is designed to prevent further

deterioration of the credit union's financial condition. Before
recommending such an order, the examiner should encourage the
Page 30-35
EXAMINER'S GUIDE
board of directors to voluntarily transfer the appropriate amount to a

special reserve account.
Recommending The examiner will recommend Special Reserve for Losses to the
SpeciaI regional director, based on examination or supervision information and
Reserves for with the supervisory examiner's concurrence. The basis for the
Losses recommendation should be set forth in a separate memorandum and be
part of the administrative record. Any order issued, along with the
administrative record, should be retained.
Under Section 216 of the Federal Credit Union Act and Part 702 of the
Rules and Regulations, NCUA may take supervisory actions that are
similar to those available by using the foregoing administrative
actions. These supervisory actions may include dismissing directors or
senior management officials, ordering the employment of qualified
senior executive oficers, liquidation or conservatorship, and any other
reasonable actions to carry out the purposes of prompt corrective
action. Unlike many of the above administrative actions, the actions
taken under prompt corrective action do not require administrative
hearings before an administrative law judge. When considering
administrative actions for a credit union which is undercapitalized,
significantly undercapitalizd, or critically undercapitalized, the
examiner should therefore also consider whether or not the desired
result could also be achieved by employing NCUA's powers under
prompt corrective action.

- 120(b) - Powers of the Board and Administration PersonneI
- Title I1 - Share Insurance
- 201 - Insurance of Member Accounts
- 206 - Termination of Insured Credit Union Status
Cease-and-Desist Orders; Removal or Suspension
From Office; Procedure
- 207 - Payment of Insurance
- 208 - Special Assistance to Avoid Liquidation
- 2 16 - Prompt Corrective Action
Page 30-36
ADMINISTRATIVEACTIONS

- 700.2-(e) - Insolvency
- 702 - Prompt Corrective Action
- 741 - Requirements for Insurance
- 747 - Administrative Actions, Adjudicative Hearings, Rules
of Practice and Procedure, and Investigations
Page 30-37
Chapter 31
LIQUI DATI0 NS
TABLE OF CONTENTS
LIQUIDATIONS ............................................................................................................. 3 1.1

Liquidations Objective ......................................................................................... 3 1-1
Associated Risks .................................................................................................. 3 1.1
Overview.............................................................................................................. 3 1.1
Responsibility ...................................................................................................... 3 1-2
Voluntary Liquidation .......................................................................................... 3 1-3
Considering Voluntary Liquidation ......................................................... 3 1-4
Alternatives to Voluntary Liquidation ..................................................... 3 1-4
Solvency Evaluation ................................................................................ 3 1-5
Commencement ....................................................................................... 3 1-5
Financial Assistance................................................................................. 3 1-6
Sale/Collection of Assets ......................................................................... 3 1-6
. . . ...................................................................................
Partial Distribution 3 1-7
Other Priorities ......................................................................................... 3 1-7
Supervision during Voluntary Liquidation .............................................. 3 1-8
Involuntary Liquidations ...................................................................................... 3 1-9
Title I Involuntary Liquidations ............................................................... 3 1-9
Title I1 Involuntary Liquidations.............................................................. 3 1-10
Payout of Federally Insured State Credit Unions ..................................... 3 1-11
Preparing Credit Unions for Involuntary Liquidation .............................. 3 1-11
Failure to Commence Operations ........................................................................ 3 1-11
Workpapers and References................................................................................. 3 1-12
Chapter 31
LIQUIDATlONS
Liquidations 0 Determine the liquidation types available
Objective 0 Determine the procedures of the various types of liquidations
Associated 0 Reputation risk can occur when the credit union sustains losses
Risks sufficient to result in liquidation. Although reputation risk is the
primary risk, the liquidation process most likely results from high
risk in any or all of the remaining six risk areas.
Overview In order to carry out that part of district responsibility relating to

liquidations, the examiner must have a thorough knowledge of the
types of liquidations and the procedures governing each. Liquidations
are classified as follows:
0 Voluntary. Part 710 of the NCUA Rules and Regulations provides

guidance for the voluntary liquidation of a solvent federal credit
union. The credit union's board of directors or a duly appointed
liquidating agent conducts voluntary liquidations. The board or
liquidating agent fully disburses members' shares in a voluntary
liquidation only after selling or collecting the assets and satisfiing
any liabilities. Also, in most cases the members receive a
liquidating dividend. For these reasons, the board or liquidating
agent should expedite the liquidation process.
0 Title I Involuntary. Under tj 120 of the FCU Act, the NCUA Board
can place a solvent federal credit union into involuntary liquidation
for violations of its charter, its bylaws, the FCUAct, and the
NCUA Rules and Regulations. Also, under 5 120, the NCUA Board
can place a federal credit union into involuntary liquidation upon
finding that the board or liquidating agent did not conduct a
voluntary liquidation in an orderly or efficient manner or in the
best interests of the members.
Page 31-1
EXAMINER'S GUIDE
Title I1 Involuntary. $207 of the FCUAct requires the NCUA

Board to close for liquidation any federal credit union it deems
bankrupt or insolvent. In these cases, the NCUA Board must also
appoint itself as liquidating agent. In addition, the NCUA Board
can accept appointment as liquidating agent of a bankrupt or
insolvent federally insured state-chartered credit union.
Purchase and Assumption. A purchase and assumption (P&A) is an

action similar to a merger, but unlike a merger the NCUA Board
places the credit union into involuntary liquidation. In a P&A,
another credit union or another financial institution assumes all or
part of the assets, liabilities, and shares.
Responsibility The NCUA Board has delegated to the Asset Management and
Assistance Center (AMAC) the responsibility of managing all
involuntary liquidations of federally insured credit unions in all NCUA
regions. AMAC processes in an orderly manner the payment of insured
shares, sale or collection of loan portfolios, the liquidation of other
assets, and the cancellation of charters or insurance certificates. In
addition to the liquidation responsibility, AMAC can assist the
examiner, if the regional director so requests, with evaluating real
estate assets, bond claims, other major assets, records reconstruction,
and management. These evaluations of operating credit unions can
help develop alternatives to liquidation or help support the insolvency
calculation.
When AMAC staff is onsite during an involuntary liquidation, the

region retains full responsibility for a federal credit union up to the
point of delivery of the Notice of Liquidation to the credit union
officials. In the case of a federally insured state-chartered credit union,
the state regulator retains full responsibility until NCUA has accepted
the appointment as liquidating agent. Once delivery of the Notice of
Liquidation takes place, or NCUA has accepted appointment as
liquidating agent, the liquidation becomes the responsibility of AMAC.
When AMAC staff is not onsite, the region retains full responsibility
until the region ships and AMAC receives the records. At that time
AMAC assumes responsibility.
Page 31-2
LIQUIDATIONS
The region is responsible for purchase and assumptions. AMAC

usually performs the administrative activity necessary to complete the
P&A. For example, AMAC can become involved in those cases in
which expense payments are necessary (not including 208 Assistance
to facilitate the action), when the continuing institution does not
receive all assets and liabilities, and when NCUA retains bond claims.
In these cases, AMAC takes responsibility for the remaining assets,
liabilities, expense payments, and bond claims on the effective date of
the purchase and assumption. The region must involve AMAC during
the planning stages of the P&A, so that AMAC can promptly publish
notices and AMAC can assume responsibility for any remaining assets
and liabilities.
The region must also supervise voluntary liquidations. AMAC, if

requested by the region, can provide assistance in the liquidation of
assets or the payment of liabilities. AMAC can also accept
appointment as liquidating agent and complete the entire voluntary
liquidation. The region and AMAC determine the degree of AMAC
involvement case by case.
The regional office and AMAC must closely coordinate liquidations.

In most cases, staff fiom both the region and AMAC conducts
involuntary liquidations. Generally, after the planning stage, regional
staff performs much of the onsite phase and ship the records to
AMAC. AMAC then conducts the share payout, prepares loan
registers, arranges for the sale or collection of the loans, and concludes
the affairs.
Voluntary AMAC or other designated liquidating agents or the credit union

Liquidation officials conduct a voluntary liquidation. Once credit union notifies the
regional office of a voluntary liquidation, the examiner should contact
the credit union to determine the current financial situation and to
provide guidance on voluntary liquidation procedures. The examiner
should ensure that the officials or liquidating agent understand and
comply with Part 7 10 of NCUA Rules and Regulations and the
Voluntary Liquidation Procedures for Federal Credit Unions (NCUA
8040).
Page 31-3
EXAMINER'S GUIDE
Considering Frequently, credit union officials will consult with the examiner
Voluntary regarding the advisability of liquidation. Examiners must carefully
Liquidation analyze all pertinent conditions to learn the true reason the officials are
considering liquidation.
Some problems for which practical solutions short of liquidation may

exist include: withdrawal of support by the parent organization,
delinquent loans, lack of interest, or disputes between officials or
factions within the credit union. Resolution of existing problems will
depend on the examiner's ability to make use of the facts uncovered in
the investigation.
The examiner may suggest reorganizing the officials, restructuring the

operating procedures, and reviving interest among the officials and
members as viable alternatives to liquidation. To accomplish this, the
members or representatives of other local credit unions may decide to
meet. The examiner should inform the supervisory examiner of the
progress made.
The examiner or regional office provides a copy of the Voluntary

Liquidation Proceduresfor Federal Credit Unions to the board of
directors. The examiner should urge the officials to take all necessary
steps to protect the members' interests and to complete the liquidation
as rapidly as possible.
Alternatives to The credit union and examiner should explore all alternatives to
Voluntary liquidation. In addition to reorganization of the officials, alternatives
Liquidation include changes to the field of membership and merger. An extension
of the basic field of membership could result in a more viable group.
For example, conversion from an occupational to a community or
associational charter provides a broader membership base. (For further
guidance, see NCUA's Chartering and Field of Membership Manual,
NCUA 8007.)
Both NCUA and the credit union may prefer a merger option to
liquidation since credit union service can continue. Regional and field
staff must weigh continued credit union service against other factors,
such as the costs to the NCUSIF. The examiner should investigate the
Page 31-4
LIOUIDATIONS
possibility of a merger and include all pertinent findings in a

memorandum to the regional office.
Solvency The examiner's memorandum regarding the voluntary liquidation

Evaluation proposal must document the credit union's solvency and support the
solvency determination with current financial statements, a delinquent
loan list, and a solvency evaluation workpaper. The examiner can use
the Probable Asset/Share Ratio form as a solvency evaluation
workpaper. The Credit Union Merger Procedures and Merger Forms
Manual, (NCUA 8056) includes a copy of the Probable AssevShare
Ratio form. The examiner should determine the actual cash value of
each asset and discuss in the memorandum any asset assigned a value
less than book value with the reasons for the valuation. Examiners
should report current loans that are probable losses, such as
bankruptcies, on the list as classified. If the credit union is insolvent,
the examiner should recommend that the regional director place the
credit union into involuntary liquidation under $207 of the FCU Act.
5700.1 of the NCUA Rules and Regulations defines insolvency.
Insolvent credit unions cannot choose voluntary liquidation.
Commencement The commencement date of the liquidation is the date the board of
directors votes to submit the question of liquidation to the members. If,
for some reason, the examiner feels this date would not result in an
equitable distribution to the members, the examiner should contact the
supervisory examiner to decide on appropriate action. The regional
director has the authority to change the date of liquidation to provide
equitable treatment of all members.
An example of inequity is a situation where the officials induce

borrowers to transfer shares to current loans just prior to the board's
announcement of the voluntary liquidation. By reducing the amount of
shares at the commencement date, a select number of shareholders
would receive a larger liquidating dividend. Inequity would also apply
in a case where, just prior to the liquidation date, the officials pressure
members with large share balances to close their accounts under the
misconception of a prolonged period awaiting final distribution.
Page 31-5
EXAMINER’S GUIDE
The examiner should instruct the liquidating agent to use the cash basis
rather than the accrual basis of accounting during liquidation. The
liquidating agent should follow procedures outlined in the Accounting
Manual for Federal Credit Unions, except that the liquidating agent
should not close income and expense accounts at year-end.
The examiner should determine that the liquidating agent closed the
books and prepared commencement reports as of the liquidation
commencement date in compliance with the Voluntary Liquidation
Procedures Manual. If the liquidating agent cannot prepare and mail
the reports and schedules to the regional office during the contact, the
examiner should obtain a firm date from the liquidating agent for
completion of these requirements. The examiner will follow up by
telephone or other means to determine that the liquidating agent keeps
the agreements.
The examiner may suggest that the board of directors authorize late
charges on inactive accounts under par value, as provided by the
bylaws, prior to closing the books. Also, staff should resolve out-of-
balance conditions at this time, where possible.
Financial In some cases, the credit union cannot convert assets to cash to
Assistance facilitate a prompt share distribution. This may occur when the credit
union cannot arrange a bulk sale of loans or when surety delays
settlement of a bond claim. The examiner may consider requesting
assistance under $208 of the FCUAct. In these cases, the NCUSIF can
purchase the assets to expedite the share distribution. Before
discussing such assistance with the officials, the examiner should
contact the supervisory examiner.
When the NCUSIF acquires assets as a result of voluntary liquidations,

AMAC is responsible for the sale, collection, or settlement of the
assets.
Sale/Collection Since the duration of the liquidation usually depends on the collection
of Assets of loans, the examiner should emphasize that a bulk sale of loans will
shorten the liquidation period and that the credit union might negotiate
a more favorable price early in the liquidation. If the sale of loans or
Page 31-6
LIQUIDATIONS
other major assets will not produce sufficient funds to pay the
shareholders at par (100 percent), the credit union may not
consummate a sale without the written approval of the regional
director.
Credit unions needing assistance in selling loan portfolios may contact

AMAC through the regional office for marketing assistance. While the
bulk sale of loans will, in most cases, be the practical way to provide a
quick distribution to the shareholders, the examiner should not
encourage the officials to sell at an excessive discount, especially if the
credit union is financially sound. Under these conditions the officials
may want to continue to collect the loans in order to provide the
members a liquidating dividend.
Partial The examiner will occasionally receive inquiries concerning partial

Distribution distributions. Current policy discourages partial distributions if the
credit union will most likely fully liquidate within six months.
However, in cases where conversion of all assets to cash will extend
beyond six months, the examiner should encourage a partial
distribution. A partial distribution generally is at least 25 percent of
total shares, and any subsequent partial distribution normally is not
less than 25 percent of commencement shares. Before payment of a
partial distribution, the credit union must request and obtain the
approval of the regional director. The voluntary liquidation procedures
specify the reports, which should accompany this request.
Auditing responsibilities of the supervisory committee do not cease

Other Priorities because the credit union enters liquidation. Rather, internal controls
take on greater importance with the conversion of the credit union’s
assets to cash and the responsibility for the liquidation frequently
delegated to one individual.
Part 7 10 of the NCUA Rules and Regulations requires bond coverage

for at least four months beyond the date of final distribution. The
importance of surety coverage increases because of the accumulation
of cash.
Page 31-7
EXAMINER'S GUIDE
When the examiner or liquidating agent determines that the credit

union can return members' shares at par, the credit union returns the
NCUSIF capitalization deposit. Credit unions that do not start final
distribution of the members' checks by December 3 1 must pay the
annual operating fee for that year. For the purpose of assessing
operating fees, NCUA considers the final distribution made when the
liquidating agent mails the members' checks.
Supervision A voluntary liquidation remains the district examiner's responsibility

during until cancellation of the charter. Voluntary liquidations normally
Voluntary conclude in one year or less, and examiners normally do not conduct
Liquidation examinations during liquidation. In rare cases, the regional office will
assign necessary examinations. While examiners will ordinarily follow
regular examination techniques, the regional director will determine
the scope of the examination. Regional instructions will guide the
examiner.
The examiner will make supervision contacts monthly throughout the

liquidation unless the board appoints AMAC as liquidating agent.
Onsite contacts will occur if the examiner cannot obtain sufficient
information by mail and by telephone to properly monitor the
liquidation. The examiner's duties will extend into such areas as:
Determining that the records are current and in balance;

0 Determining that prescribed procedures are being followed;
0 Coordinating the sale of loans and other assets;
0 Monitoring solvency;
Submitting prompt and accurate reports to the regional office; and
0 Bringing the liquidation to a prompt conclusion.
Immaterial differences between the individual share and loan ledgers

and their control accounts should not delay distribution. If material
differences exist, the examiner should obtain guidance from the
The examiner should conduct a joint conference at the conclusion of

onsite contacts if the officials continue to run the credit union.
Examiners should discuss any exceptions or irregularities with the
responsible officials and take appropriate steps to ensure necessary
Page 31-8
LIQUIDATIONS
corrections. If unsatisfactory practices jeopardize the interests of the

shareholders and NCUSIF, the examiner should ensure that the
officials discontinue these practices immediately.
Examiners will report by memorandum to the regional office on each

supervisory contact for a liquidation. The memorandum should briefly
state:
0 The conditions found;

0 Instructions given to and agreements reached with the liquidating
agent and the officials;
0 Any information specifically requested by the supervisory
examiner; and
0 The anticipated date of distribution.
The examiner should continue to contact the credit union even after the
final distribution. NCUA finalizes the liquidation only after receiving
the final reports and canceling the charter.
Involuntary The Administrative Action chapter explains the procedures for placing
Liquidations an operating federal credit union into involuntary liquidation.
When the NCUA Board places a federal credit union into involuntary
liquidation or NCUA accepts appointment as liquidating agenureceiver
for a federally insured state credit union, the regional office notifies
AMAC. The regional director and president of the AMAC should
decide early in the planning process if AMAC staff must be onsite at
commencement of liquidation. The Field Examiners Liquidation
Guide to On-Site Involuntary Liquidation Procedures, (NCUA 9700)
provides detailed guidance on the liquidation procedures.
Title I Although Title I of the FCUAct provides that the NCUA Board may
Involuntary place a federal credit union into involuntary liquidation because of
Liquidations insolvency, Title I does not provide for the related payout. Therefore,
NCUA conducts all liquidations of insolvent federal credit unions
under the authority of $207 of the FCU Act, and uses Title I for
liquidations involving violations of the charter, bylaws, FCU Act, and
Page 31-9
EXAMINER'S GUIDE
NCUA Rules and Regulations. AMAC, as liquidating agent, conducts

Title I involuntary liquidations.
Since Title I liquidation is not a commonly used administrative action,

examiner involvement will differ from case to case. For this reason,
the regional office will issue any needed assignments to examiners for
each case. The examiner will discuss with the supervisory examiner
the decision to recommend involuntary liquidation of a solvent federal
credit union.
Title II The examiner will submit to the regional director a recommendation to

lnvoluntary place an insolvent federal credit union into involuntary liquidation,
Liquidations who will request concurrence from the Office of General Counsel. The
following data should support the recommendation:
Summary of the credit union's history and background;

Summary of the field of membership;
Economic conditions of the local area;
Merger feasibility;
Officials' involvement; and
Previous examination information such as, CAMEL, sol 'ency
evaluation ratio, delinquency, etc.
The recommendation should include the following current reports:
Balance sheet;
Income statement;
Delinquency report;
Classified loans;
Solvency evaluation workpaper;
Any outstanding Letter of Understanding and Agreement;
All Preliminary Warning Letters; and
Other administrative actions.
Current financial statements, the delinquent loan list, and a solvency

evaluation workpaper should support the credit union's insolvency.
The examiner should: (1) determine the actual cash value for each
asset; (2) discuss in the memorandum any assets assigned a cash value
less than book value and the reasons for the valuation; (3) mark the
delinquent loan list to indicate the classified loans; and (4) report
Page 31-10
LIOUIDATIONS
current loans which are probable losses, such as bankruptcies, on the

list as classified.
Basically, the instructions in the Administrative Actions chapter of this

Guide dealing with an operating, solvent credit union will apply to a
liquidating, insolvent credit union.
In the case of a liquidating credit union, it is not necessary to cite any

other charges other than insolvency in the recommendation to the
regional director. If the regional director so requests, AMAC can assist
the examiner in evaluating complex assets, bond claims, and records
reconstruction to make the solvency determination.
Payout of When the appropriate state authorities declare an insured state credit
Federally union insolvent or bankrupt, the state usually appoints NCUA or the
Insured State NCUA Board as liquidating agent, receiver, or conservator. Under
Credit Unions delegated authority the president of AMAC, becomes the liquidating
agent in these cases.
NCUA does not have the authority to place a state-chartered credit

union into liquidation. NCUA cannot make the formal determination
of insolvency. The regional director will make any examiner
assignments in these liquidations. Examiners will follow NCUA's
procedures to the extent that they do not conflict with state law.
Preparing Credit The primary goals of an involuntary liquidation are the prompt return
Unions for of members' shares, payment to the creditors, and disposition of the
Involuntary remaining assets to the NCUSIF. Once the regional director has
Liquidation decided to liquidate the credit union, the examiner must ensure that the
records are current and in balance. The regional director determines the
examiner's role during the liquidation case by case. If the examiner is
to conduct the onsite phase of the liquidation, he or she should use the
Examiners Liquidation Guide to On-Site Involuntary Liquidation
Procedures for detailed guidance.
FaiIure to When the regional office receives notice that a new credit union will
Commence not start operations as scheduled, it will assign an examiner to
Operations determine if the region should liquidate the credit union. If the
Page 31-11
EXAMINER’S GUIDE
examiner’s efforts to commence operations are unsuccessful, the

examiner should submit the following to the regional office:
0 The original charter and share insurance certificate; and

0 A letter or statement signed by a majority of the directors which
includes:
- Request for revocation of charter;

- Reason for not beginning operations;
- Information as to the disposition of the initial supplies.
and - Solvency Evaluation Workpaper
References 0 References
Title I - General Provisions
Title I1 - Share Insurance
120 - Powers of the Board and Administration
207 - Payment of Insurance
208 - Special Assistance to Avoid Liquidation
700.2(e)(l) - Insolvency
709 - Involuntary Liquidations
7 10 - Voluntary Liquidation of Federal Credit Unions
745 Subpart B - Payment of Share Insurance
- Voluntary Liquidation Procedure for Federal Credit
Unions (NCUA 8040)
- Field Examiners Liquidation Guide to On-Site Involuntary
Liquidation Procedures
- Credit Union Merger Procedures and Merger Forms Manual
Page 31-12

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FOREWORD

The June 2002 revision of the Examiner’s Guide is a comprehensive

The risk-focused program is a forward-looking program designed to

Required examination procedures have decreased to three: (1)

The Automated Integrated Regulatory Examination System (AIRES)

Representatives from the National Association of State Credit Union

Finally, a reminder that the Examiner's Guide remains a guide, not a

Risk-Focused Program ............................................................................. Chapter 1

Types of Share Accounts ............................................................. Appendix 14A

RISK FOCUSED PROGRAM

RISK-FOCUSED PROGRAM ........................................................................................ 1-1

Overview A risk-focused program is a forward-thinking approach that allocates

In the risk-focused program, distinctions between examination and

Supervision is the ongoing monitoring of a credit union's financial and

The examiner, through other examiners, trade associations, credit

Management's due diligence involves the analysis of new products and

and effectiveness. This analysis would include periodic cost-benefit

If the risk to the credit union increases as a result of offering a certain

Risk-Foc used Risk, by definition, implies uncertainty. While performing risk-focused

Financial indicators, while useful, often represent lagging indicators.

0 Due diligence review by management for new and existing

Risk is fundamental to the operation of a credit union. Examiners,

A credit union’s capital or net worth constitutes the reserve of funds

Risk-Focused In the risk-focused examination, the content of the examination centers

The risk-focused program provides examiners the flexibility to focus

Reviewing the accuracy of the 5300 Call Report data;

Examiners must complete these minimum procedures during each

In carrying out the risk-focused examination program, examiners

(also referred to as operating or fraud risk) is a function of internal

Compliance risk goes beyond a failure to comply with consumer

services, or to continue servicing existing relationships. This risk,

Managing The key to effective risk management is management. Effective risk

Effective risk management also requires capable management and

0 Implementing the board’s strategic direction;

0 Developing formal and informal policies compatible with the

0 Overseeing development and maintenance of timely, accurate, and

0 Ensuring effective communication of, and adherence to, strategic

size, complexity, and geographic diversity of each credit union

0 Risk identification. Proper risk identification focuses on

0 Risk measurement. Accurate and timely measurement of risks is a

0 Risk control. The credit union should establish and communicate

0 Risk monitoring. Credit unions should monitor risk levels

Policies, When examiners assess risk management programs, they should

Policies reflect the board’s intent and commitment in pursuing desired

Processes include the procedures, programs, and practices governing

Personnel encompass the staff and managers executing or overseeing

Control systems are tools and information systems managers use to

Measuring Ensuring effective risk-focused supervision requires a common

Assessment of risk must reflect both a current and prospective view of

Effectively communicating the rationale for decisions in evaluating

0 Quantity of risk - the level or volume of risk (low, moderate, or

Quality of risk management - how well management identifies,

Aggregate risk - a summary of the level of supervisory concern

Direction of risk - assessed as decreasing, unchanged, or

One of the most significant influences on the anticipated direction

Examiners’ expectations of risk to increase or decrease do not

Institution risks are more subjective and include:

Although the risk-focused examination and supervision process

For example, compliance laws exist for protection of the consumers.