Addressing Concentrations of Risk
Twenty Twenty Analytics is a joint venture between Goldstein
Schechter Koch and Kirkland, Russ, Murphy & Tapp
www.gskcpas.com & www.krmtcpa.com
Current Guidance
• Supervisor Letter – Concentration Risk, 10-CU-03
issued by the NCUA March 2010
• Non-Authoritative Guidance, released by the NCUA
during 2008, Multi-Dimensional Portfolio Analysis
(MDPA)
Concentration Risk
• What is concentration risk?
– A risk concentration is any single exposure or
group of exposures with the potential to
produce losses large enough (relative to
capital, total assets, or overall risk level) to
threaten a financial institution’s health or
ability to maintain its core operations.10-CU-03
Types of concentration risk
• Asset classes (e.g. residential real estate loans,
member business loans, automobile loans, loan
participations or investments).
• Concentrations within a class of assets. Examples
include, but are not limited to:
• Loans to one borrower or associated group of
borrowers (may include several different types of
loans – residential real estate, MBLs, consumer
loans, etc).
Types of concentration risk - continued
• Residential Real Estate Loans – collateral type, lien
position, geographic area, non-traditional terms
(such as interest-only, payment option, or balloon
payment), fixed or variable interest rate, low or
reduced underwriting documentation, and loan-tovalue (LTV).
• Member Business Loans (MBLs) – types of loans
(e.g. real estate, working capital, and credit cards),
collateral type, payment feature (such as interestonly, balloon payments), loan term, geographic
area, and LTV.
Types of concentration risk - continued
• Loan Participations – types of loans (e.g. residential
real estate, MBL, and automobile) and the subclasses associated with the types, originating lender,
and geographic area.
Highlights 10-CU-03
• Management is to perform a risk assessment which
demonstrates their understanding of the risk of the
product or service, quantifies the potential loss
exposure and documents a rational business
decision on the acceptable concentration level
based on the analysis.
• Create data processing systems capable of
warehousing data on various lines of business,
commensurate with its size and complexity, to
properly identify and measure concentration risk.
Highlights 10-CU-03 - continued
• Develop effective, accurate and timely risk rating
systems for managing concentration of risk in the
loan portfolio. These risk ratings should be objective,
sensitive to changes in the borrower and/of loan
characteristics – which are validated via an
independent review function.
Highlights 10-CU-03 - continued
• Management to provide timely and periodic reports,
in a format that clearly indicates changes in
concentration risk – commensurate with size,
complexity and risk exposure. These reports should
not only measure concentration of risk against board
approved parameters but should measure how the
risks change over time.
Highlights 10-CU-03 - continued
• Establish a policy which addresses its philosophy on
concentration risk, limits commensurate with net
worth levels and the rationale as to how the limits fit
into the overall strategic plan of the credit union.
• Perform routine portfolio-level scenario and
sensitivity tests to quantify the impact of changing
economic conditions on asset quality, earnings and
net worth. The analysis should predict possible
future outcomes given an event or series of events.
Highlights 10-CU-03 - continued
• The analysis should additionally be multi-faceted to
explore the effects of a single event or multiple
negative events on the portfolio.
• Provides new guidance for examiners conducting
audits of credit unions to ensure that all of the
guidance included in the letter have been
considered
Highlights 10-CU-03 - continued
• The board of directors must establish a policy which
addresses its philosophy on concentration risk, limits
commensurate with net worth levels, and the
rationale as to how the limits fit into the overall
strategic plan of the credit union.
• Once the appropriate risk management systems and
policies are in place, it is essential monitoring and
oversight become routine functions at the senior
management level within the credit union.
Multi-Dimensional Portfolio Analysis
• MDPA is a forward looking process for conducting a
global analysis of credit portfolios; it includes the
identification and analysis of risk factors, both at the
point of loan origination and periodically afterward.
By moving from a single point of risk analysis
(origination) to a method that incorporates ongoing
review of the changing credit quality within a
portfolio, credit unions are able to establish a
proactive system of risk identification and mitigation.
Multi-Dimensional Portfolio Analysis
• MDPA is expected to reduce the aggregate number
and amount of non-performing credits as ongoing
monitoring helps management to identify and
mitigate changes in risk profile.
Multi-Dimensional Portfolio Analysis
• Step 1: Identify risk factors, such as credit scores,
market collateral values, or levels of unsecured
debt, that are indicative of changes in credit quality
since origination.
• Step 2: Establish risk thresholds and risk categories
for the purpose of ongoing monitoring. These
thresholds may be different than initial underwriting
standards, and the thresholds should be specific to
various product types.
Multi-Dimensional Portfolio Analysis
• Step 3: Develop reporting system to track current
risk category of individual credits and summarize
key information in aggregate reports.
• Step 4: Identify trigger points when action will be
taken to mitigate risk associated with a particular
credit. For example, if current loan-to-value rises
above 120 percent, access to unused portions of a
home equity line may be restricted.
Multi-Dimensional Portfolio Analysis
• Step 5: Define risk mitigation strategies for risk
categories. Strategies should be customized to
consider the product type, risk factors, and level of
exposure (potential loss amount).
• Step 6: Take action to implement risk mitigation
strategies.
Multi-Dimensional Portfolio Analysis
• Step 7: Continue periodic monitoring of portfolios.
Identify changes in risk factors that move individual
credits to different risk categories. Measure
individual credit and portfolio risk levels against
defined thresholds for action. Frequency of risk
identification efforts should be linked to exposure
(portfolio impact to net worth) and risk levels (higher
risk portfolios would warrant more frequent
monitoring).
Multi-Dimensional Portfolio Analysis
• Step 8: Report on changes in portfolio, identify high
risk credits, and continue cycle by taking action to
implement appropriate risk mitigation strategies.
• Step 9: Periodically test results of MDPA by adding
new risk factors and/or eliminating factors that do
not generate reliable results. Credit unions should
expect to see changes in predictive risk factors over
time, as conditions change within the field of
membership and economy.
Who We Are
• Twenty Twenty Analytics is a company that
specializes in the review and homogeneous analysis
of loan portfolios for credit unions.
• We have developed a series of models that can be
instrumental to your management team in
identifying, analyzing and monitoring concentrations
of risk within your loan portfolio.
• Each of our models is customizable to your specific
needs and we have a proven record of validating
and identifying economic risks and uncertainties that
expose your portfolio to risk.
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