FT. LAUDERDALE, Fla.-CFOs were urged to consider a new risk matrix model for examining threats to their organizations and to meet regulatory demands.

Daniel Frilot, senior risk consultant with Balance Sheet Solutions, a CUSO of Alloya Corporate, proposed credit unions develop a Risk-Based Net Worth matrix in analyzing risk on a broader scale.

The reasons for such analysis, he said, are clear, citing NCUA's own statement that its 2012 supervisory focus will be on "credit unions with elevated levels of credit risk, interest rate risk, liquidity risks, and concentration risks."

In total, those factors are the "holistic" view of risk that must be managed, noted Frilot, citing NCUA Board Member Gigi Hyland's use of that word. "It sounds warm and fuzzy, but it's about being able to manage the risk of the whole balance sheet," said Frilot. "NCUA expects us to be aware of the material concentration that exist within the balance sheet and to take appropriate steps to measure, monitor and control such concentrations."

With NCUA's particular focus on concentration risk, Frilot said he sees the regulatory scrutiny as an opportunity. "I look at this as an advantage because they are looking to us to define this. This gives you some flexibility to approach concentration risk in a logical manner that works best for your organization."

The risks on any balance sheet are well-known to any CFO: credit default risk, interest rate risk, liquidity risk, price/market risk, operational risk, third party risk, etc. "The concern is do we have a process in place that puts all those risks in front of us that provides a clear perspective we can quantify and we can measure against our capital position," asked Frilot. "These are the risk drivers that make up concentration risk as a whole. Individually you might have all of these well in hand and managed on a frequent basis. The goal is to get these into a concerted plan in order to make better decisions."


A List of 'Suspects'

That list of concentration risk "suspects" includes, noted Frilot:

* Residential mortgage (first and second lien portfolios). "Recent loan performance is not consistent with historical performance through the latest economic cycle. Your real estate portfolio may not act like it did 10 years ago."

* MBLs (in a specific business or industry segment)

* Subprime and indirect loans

* Mortgage-related securities. "Many CUs are seeing investment portfolios becoming a stronger part of the balance sheet, and it's a bigger risk," said Frilot. "But you also have risk when you park a lot of funds in overnight deposits with 10- or 20-basis point yields."

* Loan Participations

* Limited share product diversification

* Unsecured loans

* Single credit and borrowing source

"If you are a credit union that only has two or three different core deposits, that may or may not present a risk to you," observed Frilot. "If you have a relatively robust term deposit book of business, and maybe you've seen them start to mature and now they are sitting in your three or six month bucket, that could be seen as a concentration risk when they mature and reprice."

Speaking to the CUNA CFO Council Conference, Frilot reminded his audience, "You need to ask, 'what could potentially go wrong with this?' "

"Loan level risk factors make a material difference," he said. "Risk factors are not isolated from one another; one risk driver may trigger another risk driver. How you construct products and how they are established in terms of collateral and credit, all that is fed into your calculations is there at your fingertips and you need to be able to take that and use it in this risk management process.


The Risk Management Challenge

The risk management challenge, he said, is to capture the entire balance sheet at appropriate loan, investment and share/liability product levels, and to allocate relevant risk components (interest rate risk, price risk, credit loss risk, etc), to products based on weighted average percentage to total assets.

That process, he said, is what leads to the creation of a Risk-Based Net Worth (RBNW) Matrix. "You want to be able to create, stratify, subtotal, link and aggregate balance sheet products based on characterstics," he said. "You can adjust and rationalize product concentration limits based on net worth profile. You are trying to create one measure you can quantify and determine where you are at in this environment, and then put into perspective of your net worth."

Frilot said CUs likely already have 75% of that information available to them, and can then build a model that adds layers of risk. For the Matrix's operational risk component, he suggested using the BASEL II definition.

"Once a minimum RBNW requirement is known, you can use the RBNW Matrix to add and subtract product volume and evaluate pro forma impact to the minimum-required RBNW target."

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